Why We Still Do Year-End Tax Settlements Started During Park Chung-hee Era [Seungseop Song's Financial Light]

Year-End Tax Adjustment Originated from System Reform in December 1974
Purpose: Minimize Tax Resistance and Ensure Efficient Collection
What If Company Withheld More Tax Than Actual?
Year-End Tax Adjustment Calculates and Refunds at Once
Bonus of the 13th Month Is an Illusion... Excessive Spending Is Harmful

The year-end tax settlement season has returned. It is also a time for office workers nationwide to reflect on their spending to save on taxes. Since it is not an easy task, it can sometimes feel bothersome. It may seem unnecessary, and it can feel unfair if you have to pay more money. However, the year-end tax settlement is one of the strengths of Korea's tax administration. It is also a necessary system. When and why did the year-end tax settlement start?

Materials from the Cabinet meeting held on December 17, 1974. The recipient of the minutes was the President (Park Chung-hee). At that time, the meeting was chaired by Kim Jong-pil, the 11th Prime Minister. During the meeting, the promulgation of the amended Income Tax Act and other matters were approved. Year-end tax settlement began in Korea starting in 1975. Source: Ministry of the Interior and Safety, National Archives of Korea

Materials from the Cabinet meeting held on December 17, 1974. The recipient of the minutes was the President (Park Chung-hee). At that time, the meeting was chaired by Kim Jong-pil, the 11th Prime Minister. During the meeting, the promulgation of the amended Income Tax Act and other matters were passed. Year-end tax settlement began in Korea starting in 1975. Source: National Archives of Korea, Ministry of the Interior and Safety

The history of the year-end tax settlement dates back about 50 years. It was during the presidency of Park Jeong-hui. In December 1974, with the revision of the income tax system, the year-end tax settlement system was legally introduced for the first time, and it officially began in 1975, the following year.

Of course, the implementation of such an advanced system as the year-end tax settlement was made possible by proactive tax reforms. In 1970, the National Tax Service established a computer center and promoted the computerization of tax administration. In 1974 and 1976, to increase trust, the National Tax Service dismissed 373 corrupt tax officials in a large-scale internal purge. The Basic National Tax Act enacted in 1974 is also praised for improving tax administration efficiency and enhancing taxpayers' rights.

However, compared to the current year-end tax settlement, there were significant differences in content and method. There were far fewer items, and the process was simpler. There were no special income deductions or tax credits. The preview or simplified services currently available through the National Tax Service were unimaginable. If you were confused or had questions about the year-end tax settlement, you had to write an inquiry addressed directly to the Commissioner of the National Tax Service and receive a written response.

Inquiry letter from a taxpayer regarding the 1975 year-end adjustment of earned income tax and the response letter sent by the National Tax Service. Data provided by the Ministry of the Interior and Safety, National Archives.

Inquiry letter from a taxpayer regarding the 1975 year-end adjustment of earned income tax and the response letter sent by the National Tax Service. Data provided by the Ministry of the Interior and Safety, National Archives.

But why did the year-end tax settlement start in the first place? To understand this, think about tax law. Tax law is very complex and difficult. Even experts struggle with it. Tax benefits and rates vary depending on various factors such as dependents, income, company size, and real estate. Therefore, it is nearly impossible for the government to calculate every citizen's tax every month. It would also waste administrative resources.

So Korea uses a system called withholding tax. Take a look at your monthly pay stub. You can see that the tax you owe has already been deducted. In other words, withholding tax is a system where employees receive their salary after tax has been deducted. In principle, taxpayers should pay their own taxes, but companies pay the taxes to the government on behalf of employees.

This method is convenient for both the government and taxpayers. The government can minimize tax resistance. Since companies pay the taxes, employees do not feel like they are paying taxes. Employees also find it convenient because a third party handles the tax payment. Without withholding tax, tax offices would be overwhelmed with visitors on tax payment days. Tax officials would be working overtime all year, and you would have to open your bank app every month to pay taxes.

However, withholding tax has a critical problem. Companies do not know your financial situation. They do not know how much your spouse earns if they also work, how many children you have, or how expensive your house is. They simply estimate the income of their employees and pay taxes collectively. As a result, there can be a difference between the tax you ultimately owe and the amount withheld. This is called the "final tax amount."

On November 29, at COEX in Gangnam-gu, Seoul, visitors listened to an explanation of an application capable of HR functions and year-end tax settlement at the "Korea Software Expo, SoftWave 2023."

Changed Year-End Tax Settlement. You can conveniently use the year-end tax settlement by utilizing the bulk provision of simplified data and preview features. Photo by National Tax Service Hometax website capture.

That is why the year-end tax settlement is necessary. The year-end tax settlement is the process of reconciling the difference between the tax withheld by the company and the actual final tax amount you owe. For example, if 10 million KRW was withheld but the final tax amount is 9 million KRW, the government has collected 1 million KRW too much. Therefore, you receive a refund of 1 million KRW through the year-end tax settlement. Conversely, if 9 million KRW was withheld but the final tax amount is 10 million KRW, you must pay an additional 1 million KRW during the year-end tax settlement.

So there is no need to be happy if you get more money back or sad if you pay more during the year-end tax settlement. The term we casually call the "13th month bonus" is the same. Getting a refund of hundreds of thousands of won at the beginning of the year may feel like free money, but in reality, it is just the return of taxes you overpaid. In the opposite case, people complain about "spitting out money," but in fact, they are paying taxes that were not withheld from their salary all at once.

One more thing. The year-end tax settlement is the difference between the withheld tax and the final tax amount. No matter how much you get refunded, it cannot exceed the amount of tax withheld. If you earn a certain amount, you cannot reduce your final tax amount to zero. Therefore, there is no need to excessively increase your spending or savings just to get a bigger refund. Again, the year-end tax settlement is not a bonus but a process of reconciling the taxes you owe and the taxes you have paid. It is enough to carefully check various tax benefits and claim 100% of the benefits applicable to you.

Editor's NoteEconomics and finance are difficult. This is because of complex terms and background stories. Financial Light delivers easy-to-understand economic and financial stories every week. Even without any prior knowledge, you can smoothly read and ignite your interest in economics and finance.