This Free IRS Tool Can Save You a Tax Bill

Filing taxes in the U.S. has evolved into a convoluted guessing game -- though I use the term "game" loosely, as it is little fun for anyone involved. Our tax system is different from many other countries.

All year long, we get to make guesses as to how much money we'll earn. Then, come April (or February, if you're one of the many early-bird filers), we get to see how close we were to what we actually owe. If you win the game, your prize is, well, nothing. Which is still better than losing, because the losers often get to pay hefty penalties.

If you come out of the Great American Guessing Game a loser more often than not, there's a tool that may help: the IRS Tax Withholding Estimator. Here's how it works.

Using the Paycheck Withholding Estimator

As the name would imply, the tool is designed for folks who get a regular paycheck from which federal income taxes are withheld automatically. (So if you're self-employed, this tool isn't going to be much help.)

Actually using the tool is fairly simple, provided you have the necessary information on hand. To start, click the big blue "Use the Tax Withholding Estimator" button. Then, you'll start answering questions about your filing status, current job, income, and current withholdings. Next come the questions about your adjustments, deductions, and eligible tax credits.

Since this is just an estimator, it's perfectly fine if you're not 100% accurate in every answer. Of course, the more accurate your answers, the better the estimate will be, so it could be worth looking up any answers you don't already know.

Once you've answered all of the questions (to the best of your ability), you'll be given your results. This will provide your expected tax withholding, your anticipated tax obligation, and the projected refund.

The goal: Get your refund to $0

All the propaganda around tax refunds make them seem like the greatest thing ever. "Hey, look at this windfall, let's buy a TV!"

Wrong. From a personal finance perspective, you actually want your refund (and, conversely, what you owe) to be exactly $0.

Why? Well, because your tax refund is exactly that: a refund. It's money that belongs to you, that you essentially loaned to the government interest-free. While that's certainly a friendly gesture on your part, it's not exactly the best use of that money.

If you can get your refund as close to $0 as possible, you'll have more money in your bank account every paycheck. That money can then be invested, added to your emergency fund, or used to pay down debt. Even if all you do is pop it into a high-yield savings account, you're going to get much better than the 0% return you're getting by loaning it to the government.

Finding the right balance

Ideally, you want to pay just the right amount of taxes throughout the year so you don't owe any money, but you don't get any money back. Sadly, this is easier said than done under the current system.

For many of us, the best we can do is get that refund down close to $0, while still ensuring we don't have to write Uncle Sam a fat check every spring. That's why the Paycheck Withholding Estimator is a handy tool. Play around with the numbers until you get to just the right withholding, and tax season -- while never fun -- will be a lot less of a dangerous game.