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Surprise! That Tax Credit May Cost You

Millions of taxpayers -  many of them seniors – could be in for an unpleasant surprise this April. They may end up owing Uncle Sam because of a snag in the Making Work Pay Credit, according to a Treasury Inspector General for Tax Administration report.  The credit, designed to put more money in your hand (so you’ll spend it) backfired on a number of other groups, too.

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TIGTA expects the credit to trip up about 13.4 million taxpayers over two years including pensioners, single taxpayers with multiple jobs, married couples with two incomes, workers without valid Social Security numbers (typically nonresident aliens), dependents who work, and some Social Security recipients who work.

The credit didn’t simply arrive as a check in your mailbox. Rather, your employer advanced the credit by decreasing your withholding so more money showed up in your paycheck. The government designed the credit to stimulate spending and fuel the economy. And that’s where the trouble started.

IRS’s adjusted withholding tables didn’t take into account the panoply of circumstances that affect withholding and eligibility, says the report. For some, that created a “vulnerability” of being underwithheld. Several taxpayers got the credit when they shouldn’t have. Still others got more of the credit than they were due. Keep in mind, though, that the affected taxpayers may not necessarily see a bill for the exact amount underwithheld. Some could see less of a refund or more of a balance due than expected, says Jackie Perlman, a tax analyst at H&R Block’s Tax Institute.

For 2009 and 2010, the Making Work Pay Credit is a refundable tax credit of up to $400 for individuals and up to $800 for married taxpayers filing joint returns. (That said, when the IRS compiled new withholding tables, they considered that a taxpayer selecting the married withholding rate could have a working spouse. To help offset the problems that come with underwithholding, the IRS set a maximum reduction for a married person at $600 rather than $800, says Perlman.) The credit phases out at a modified adjusted gross income of $75,000 to $95,000 ($150,000 to $190,000 for joint returns). To qualify, you need earned income, and you can’t be a dependent or nonresident alien.

Say you’re a working senior who received the Making Work Pay Credit as well as a one-time $250 Economic Recovery Payment—given to disabled recipients of Social Security, among other taxpayers. You’d have to reduce the amount of the Making Work Pay Credit claimed by $250. So if you got a $400 Making Work Pay Credit and the ERP you’d have to whittle down the amount of the credit claimed to $150. Some seniors didn’t know they couldn’t claim the entire credit. And some didn’t know they got the credit in the first place, says Mary Johnson, a Social Security and Medicare policy analyst at the Senior Citizens’ League.

Though a tax bill could be news to you, the headache is what’s left of a stubborn hangover from 2009. “It’s not new and it’s not a mistake,” says H&R Block’s Perlman. “Misinformation or lack of understanding of how it works” is the cause for some of the some of the unwelcome surprises. A TIGTA survey points to the fact that despite IRS outreach efforts, a majority of affected taxpayers weren’t aware of the effects of the credit or the way they could avoid negative effects of the credit.

But no need to panic, Perlman says. In most cases, “the Making Work Pay Credit will not cause sticker shock,” she says. If you’re in a lower tax bracket, you may see a tax bill in the hundreds of dollars, not the thousands. Now if you’re a senior on a fixed budget, that figure could still raise your blood pressure. If that’s the case, march in to see your tax professional as soon as possible. The IRS won’t leave you in the lurches if you keep them informed. Check out what The Tax Blog previously wrote about what to do if you owe.

The bottom line: Pay attention to your withholding. It’s your responsibility to adjust your W-4 to avoid underpayment.

Readers, do you know anyone who could be affected by this underwithholding vulnerability? Do you think the IRS did enough to educate taxpayers about this unusual situation?

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  • The Tax Blog brings together a team of award-winning tax journalists from the Dow Jones network and around the web to examine the tax issues, changes and legislation that affect families, investors and small business owners. Our contributors include Tax Report columnist Laura Saunders (WSJ), Tax Guy columnist Bill Bischoff and senior reporter Jilian Mincer (SmartMoney.com), retirement-focused reporter Anne Tergesen (WSJ), wealth management writer Arden Dale (Dow Jones Newswires), TaxWatch columnist Eva Rosenberg and personal finance reporter Andrea Coombes (MarketWatch), and reporter Alyssa Abkowitz (SmartMoney). They’ll provide the latest news and insight, mine the tax code for tips and loopholes, and answer your questions about tricky tax situations. Contact the The Tax Blog with ideas, suggestions or tax questions at thetaxblog@dowjones.com.

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