Making Work Pay Credit Could Surprise Some Taxpayers in 2010

Note from taxgirl: I’ve written a few pieces about the credit since this piece originally posted. Many of the questions and comments related to this post can be answered by checking out this updated post about sorting out the credit. You can find out more about calculating the credit here.

As of April 1, many taxpayers will see an extra few dollars in their paychecks as a result of the Making Work Pay Credit. The MWPR was part of the American Recovery and Reinvestment Act of 2009, signed into law by President Obama in February 2009. The credit will provide up to $400 per individual worker and $800 per working married couple.

The credit will be administered through cuts in withholding at the employer level. The credit will phase out for individual taxpayers with AGI in excess of $75,000 (up to $95,000) or $150,000 for married couples filing jointly (up to $195,000). If you are a higher income taxpayer, you will see little or no change in your pay.

The amount of the credit that you receive will be reported on your 2009 income tax return, which is filed in 2010, but it is not taxable and you do not have to pay it back if you received the proper amount. If you do not have taxes withheld by an employer during the year because you are self-employed or because your withholding level is too low for the credit to apply, you can claim the credit on your 2009 tax return (filed in 2010). This is a refundable credit, so if you qualify and you do not receive the entire amount, you can have any additional credit refunded to you at tax time (again, in 2010).

The changes will be made automatically through your withholding so you will not need to make an adjustment to your form W-4 come tax time for most taxpayers.

There are, however, potential problems for some taxpayers. It is possible that there could be an “over withholding” for some taxpayers. Chief among them: college students and others who may be claimed as a dependent on someone else’s return. If you are claimed as a dependent on someone else’s return, you do not qualify for the Making Work Pay Credit. This means that those taxpayers will have to return any credit paid out to them (either in the form of a payment to IRS or a reduced refund, if you normally qualify for a refund) unless an adjustment is made on a form W-4.

Additionally, married taxpayers who both work should carefully review withholding. If each spouse’s employer makes the adjustment, an “over withholding” could apply, especially in cases where combined income hits a phase out amount or if withholding from one spouse runs all of the way up the bracket (the same situation applies to taxpayers who work more than one jobs). Remember, your employer is merely reading from a tax table: he or she is not aware of your spouse’s income (or lack of) or your other employment. If you know that your combined incomes are over the phase out limits, or that your income may run up the bracket as a married taxpayer or due to holding more than one job, you should make accommodations now (either in the form of adjustments or setting money aside) so that you don’t get caught by surprise next April.

It’s also important to remember that if you do not work, you are not eligible for the credit. Retirees and the disabled are set to receive a $250 check sometime in late spring/early summer but there will be no checks for taxpayers who do not work and do not qualify as a retiree or disabled person. Keep in mind, too, that the number of children that you have will not affect your credit this year: I’ve been fielding questions from taxpayers who believed that the provisions from the last stimulus bill (in 2008) would apply for this year. They do not. Claiming additional dependents on your 2009 tax return (filed in 2010) will not increase your Making Work Pay credit.

The bottom line is that if any special circumstances apply to you, be aware of how much is being withheld from your check. Do the math if you’re worried. Assuming that you’re not phased out, to receive $400 over (roughly) the next nine months, an individual taxpayer should receive about $11 extra per week. Similarly, assuming that you’re married and not phased out, you and your spouse should receive twice that amount combined ($22/week). If you find that your withholding is more than it should be – and you’re concerned – make an adjustment on your form W-4 or talk to your tax professional.