Approximately 13.4 million taxpayers who received the Making Work Pay Credit that was included in the economic stimulus bill may end up owing taxes, according to a new government report.

The report, by the Treasury Inspector General for Tax Administration, found that overall the Internal Revenue Service implemented the credit as intended by Congress. However, because adjustments to the withholding tables did not take into consideration some taxpayer circumstances, such as single taxpayers who work more than one job, millions of taxpayers could end up owing more money on their taxes than they would without the credit.

In addition, the report estimates that approximately 108,000 taxpayers may have been assessed the estimated tax penalty by the IRS as a result of the credit, and an additional 1.02 million taxpayers may have had their estimated tax penalty amount increased.

The Making Work Pay Credit is likely to be replaced next year by a 2 percentage point decrease in Social Security payroll taxes, from 6.2 to 4.2 percent, if the Bush tax cut extension deal worked out by President Obama is signed into law.

Problems with the Making Work Pay Credit have been known since it began taking effect in 2009, but the estimate in the TIGTA report of the number of taxpayers affected is much larger than previously thought. Besides single taxpayers with more than one job, joint filers where both spouses work, or one or both of them have more than one job, have also found themselves owing more on their tax returns unless their withholding amounts were adjusted. Taxpayers who receive pension payments, and Social Security recipients who receive wages, are also among those who may be negatively affected by the credit, according to the TIGTA report.

The Making Work Pay Credit was included as an economic stimulus provision in the American Recovery and Reinvestment Act of 2009, also known as the Recovery Act. The credit is advanced to taxpayers by their employers through withholding reductions, which results in an increase in taxpayers’ take-home pay. The credit has been effective for tax years 2009 and 2010, but expires at the end of this year.

“The Making Work Pay Credit is a key tax credit designed to increase spending and stimulate the economy,” said TIGTA Inspector General J. Russell George in a statement. “However, many taxpayers who are accustomed to receiving refunds when they file their tax returns may have owed taxes and incurred penalties in 2009, and may yet again in 2010 because they were advanced more of the credit than they were entitled to claim. My office issued a report in November 2009 warning of this possibility and encouraging the IRS to increase outreach and waive penalties for taxpayers who may be negatively affected by the credit. We still believe further actions are needed to ensure no taxpayer is unfairly penalized.”

TIGTA performed an audit to assess efforts by the IRS to implement the credit, to evaluate the credit’s impact on taxpayers, and to determine if taxpayers who were negatively affected in 2009 were aware of how to avoid being negatively affected again in 2010.

TIGTA found that despite significant outreach efforts by the IRS, most taxpayers who appeared to have been negatively affected by the reduced withholding associated with the credit were not aware of the credit or its effect on their taxes.

TIGTA made two recommendations to the IRS in its report. The IRS agreed with the first recommendation and partially agreed with the second.

TIGTA recommended that the commissioner of the IRS’s Wage and Investment Division should consider including simplified withholding adjustment instructions on the IRS Web site for specific scenarios that could result in underwithholding, identify those taxpayers who owed any estimated tax penalty as a result of the Making Work Pay Credit, and notify them of the their right to have a portion of the penalty related to the credit abated.

IRS management agreed with the first recommendation and partially agreed with the second. Managers plan to continue their outreach efforts, but declined to contact taxpayers who owed any penalty based on the Making Work Pay Credit. TIGTA said, however, that it is concerned that the IRS’s corrective actions are not adequate.

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