The Tax Attic – May 28, 2008

Jerry Coon, Enrolled Agent

Jerry Coon, Enrolled Agent

Making Work Pay

tax credit

problematic

The provision of the American Recovery and Reinvestment Act of 2009 that is of most concern to tax professionals around the state of Michigan and the entire country seems to be the one titled the Making Work Pay tax credit. I have written about this credit previously, but feel that it is so problematic that I have to write one more article about it.

The basic premise of this credit is that taxpayers will receive an additional $13 to $25 per week of take-home pay during the years of 2009 and 2010. For a single person, this should amount to about $400. For joint filers, this should amount to about $800. The credit is the smallest of 6.2% of earned income or $400 single/$800 joint.

When the 2009 tax return is filed next year, a single working taxpayer will claim the Making Work Pay tax credit of $400 on the return and, since that person’s withholding should have decreased by about $400, all things being equal, the tax return shouldn’t look much different than this year’s return. Similarly, when the joint working couple file their return in 2009, their withholding should be about $800 less, but they will get the $800 Making Work Pay tax credit, and all should be okay. The taxpayers’ tax burden will have been reduced by $400 or $800 and everyone is happy.

However, there are potential problems that will result in some taxpayers not ending up in that happy place. One of the key words in the entire provision is the second word of the provision:  Making WORK Pay tax credit. In other words, for taxpayers who do not work and do not have earned income, there is no Making Work Pay tax credit. That is where problem number one arises.

When the Internal Revenue Service was instructed to implement this credit and adjust the withholding tables so that taxpayers would get the $13 to $25 additional take-home pay, there was a small communication error. They did not instruct all of those entities issuing pensions to ignore the new tables. The Making Work Pay tax credit does not apply to pension recipients. Pension income is not earned income and does not qualify as work income. However, I have many clients who had their pension withholding reduced anyway. Since they will not qualify for the $400/800 credit when we file their 2009 tax return, they could either get a reduced refund or owe an additional amount. According to Dave Ramsey, getting a reduced refund is good, and I don’t argue with that. However, for those clients who already owe just a little or try to make it all work out to zero refund, having to tell them they owe $800 more than they expected won’t do much for my well-being next tax season.

The IRS very recently released instructions to the entities issuing pensions that they should notify their recipients and give them the option of using tables that do not reflect the Making Work Pay reduction. I would recommend that taxpayers receiving pensions who did receive a decrease in withholding contact their tax professional. An adjustment might be necessary in the form of filing a new W-4 with the pension people or perhaps adjusting estimated payments. Taxpayers should not presume everything will work out, because it may not.

Problem number two arises with taxpayers who work more than one job or joint filers who both work. A single taxpayer who has more than one job potentially could be receiving $13 more take-home pay from each job. This single taxpayer is now having his/her withholding reduced by $800 during the year. However, when the tax return is prepared, only a credit of $400 will be allowed. That could result in a smaller refund or a balance due. Hello, Dave Ramsey, again.

For joint filers, it’s a little more dramatic, and I can use my own situation as an example. Deb and I both work and we both claim married-filing-jointly with zero exemptions on our W-4. We itemize, and I like Dave Ramsey, so I try to keep our refund/balance due as close to zero as possible. However, both of us had our withholding reduced by $800 by the new withholding tables. Our withholding went down by $1,600. We will qualify for $800 of Making Work Pay tax credit, but not $1,600. That means if I don’t adjust our withholding amounts, we could owe $800 when we file our return.

Say I was off just a little on my calculating and instead of getting a slight refund, we owed $300 with our return. Factor in the reduced withholding and we now owe $300 plus $800, or $1,100. Deb Coon is not a happy camper, and neither is the IRS. Because we owed more than $1,000, we can be penalized for owing them too much. Of course, our situation is just hypothetical, because I will adjust our withholding.

Taxpayers out there in a similar situation should not hesitate to contact their tax professional to have a discussion about whether they should submit a new W-4 to increase that federal withholding. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns

Action Tax Service on Northland Drive in Rockford.

His e-mail address is jcoon@actiontaxservice.com.

 

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