The Making Work Pay Credit is this year's economic stimulus to help get the economy going, just as the economic stimulus payments and related recovery rebate credit were last year's effort to stimulate the economy.

The Making Work Pay Credit is a refundable credit equal to the lesser of 6.2 percent of the taxpayer's earned income or $400 ($800 for married couples filing jointly). Although the 6.2 percent figure was selected to match the Social Security withholding rate, the credit is an income tax credit and does not affect the handling of Social Security contributions.

Because the Making Work Pay Credit is tied to earned income, Congress also decided to provide some economic stimulus to groups of people without earned income: government retirees, Social Security recipients, railroad retirement recipients, veterans' benefit recipients, and SSI payment recipients. Government retirees are entitled to a $250 credit and the other recipients receive a $250 check from their benefit provider. These $250 amounts count against the dollar limits under the Making Work Pay Credit.

Unlike the recovery rebate credit, which was advanced to taxpayers in the form of checks, the Making Work Pay Credit is being provided to taxpayers through income tax withholding reductions. The IRS has revised the withholding tables and directed employers to start using the new tables by April 1, 2009. This structure was designed with the hope that a small increase in regular paychecks was more likely to be spent than a one-time check, which last year was often used to pay down debt or invest, rather than directly stimulating the economy.

The Making Work Pay Credit is not available to nonresident aliens, individuals who can be claimed as a dependent on another taxpayer's return, an estate or trust, or a taxpayer whose return does not include at least one valid Social Security number. The Making Work Pay Credit also phases out for taxpayers with modified adjusted gross incomes between $75,000 and $95,000 ($150,000 to $190,000 for joint filers).

THE WITHHOLDING TABLES

The new withholding tables (IRS Publication 15-T) are designed, if implemented on April 1, 2009, to reduce withholding by $400 (or $600 for joint filers - the IRS decided to not do the full $800). The IRS has directed that the new withholding tables be used for all taxpayers, including pensioners who have withholding taken from pension payments.

The IRS has suggested that taxpayers who are not entitled to the full Making Work Pay Credit may want to increase withholding by filing an amended Form W-4 or W-4P. Tax advisors will probably need to be alert to assist their clients in determining if they should consider filing an amended withholding form.

UNDER-WITHHOLDING

The withholding tables should produce the correct result where there is only one source of Form W-2 income reflected on the tax return. If earnings from that employer alone are sufficient to subject the taxpayer to a total or partial phase-out, the withholding tables should take that into account and maintain sufficient withholding to reflect the reduced credit.

For many other taxpayers with more complicated, although fairly common, situations, the withholding tables are likely to produce under-withholding. The taxpayer could counteract this with an amended W-4 form. The total dollars involved in the under-withholding are not likely to be large - generally at most an under-withholding of $800 from each employer reflected on the return in excess of one. Taxpayers accustomed to refunds larger than this amount will typically just see a reduced refund. For other taxpayers, however, the under-withholding could result in additional tax due and possible penalties for underpaying estimated taxes.

The following are some of the categories of taxpayers practitioners should watch out for:

1. Dual-income couples. The tables will tend to reduce withholding from each spouse by $600, creating a potential for $600 of insufficient withholding. If each spouse's income alone is less than the phase-out limit, but the combined income exceeds the phase-out limit, the potential for under-withholding could increase to $1,200.

2. Individuals with multiple jobs. Each employer will apply the new withholding tables as if the income from that employer is the sole source of income. This could result in insufficient withholding of up to $400 per employer in excess of one for taxpayers who do not file jointly, or $800 per employer in excess of one for joint filers.

3. Taxpayers with significant business or investment income in addition to W-2 income. Taxpayers who have significant business or investment income in addition to their W-2 income may be subject to a total or partial phase-out of the credit, which will not be reflected in the amount of reduced withholding on the W-2. This could result in under-withholding of up to $400 ($800 for joint filers).

4. Government retirees or recipients of government benefit programs who also have earned income. Retirees who receive a $250 credit or check and also have earned income may have withholding on the earned income reduced by the full $400 ($600 for joint filers) without taking into account the fact that the Making Work Pay Credit is reduced by the $250 credit or check. This could result in under-withholding of up to $250 ($500 for joint filers).

5. Pensioners whose pensions are subject to withholding. The IRS has directed that the revised withholding tables be used for pensioners whose pensions are subject to withholding. Unless these taxpayers also have earned income, they will not be eligible for the credit and the revised withholding tables will result in under-withholding. A Form W-4P could be filed to increase withholding and counteract this effect.

6. Dependents with W-2 income. Dependents are not allowed to claim the Making Work Pay Credit. The employer's use of the revised withholding tables may also result in under-withholding for these individuals of up to $400.

7. Individuals without valid Social Security numbers on their tax returns. Employers may be using the revised withholding tables to withhold income on what proves to be an invalid Social Security number. Individuals who are unable to include a valid SSN on their tax returns are ineligible for the credit. Use of the revised withholding tables for these individuals is again likely to result in under-withholding.

8. Nonresident aliens. Although nonresident aliens are not eligible for the Making Work Pay Credit, the revised withholding tables do include additional amounts to be added to the pay of nonresident aliens to figure their income tax withholding. If properly done, nonresident aliens should not be subject to under-withholding. However, tax practitioners might want to verify with their clients that the additional amounts are in fact being added back to the withholding table amounts.

9. Early implementation of the withholding tables. The withholding tables were designed to be implemented on April 1, 2009. Employers were not, however, prohibited from implementing them earlier. They were released on Feb. 21, 2009. Implementation before April 1, 2009, could result in some under-withholding of income even for individuals eligible for the full credit, although the amount of under-withholding would not be as large as from some of the other situations discussed.

OVER-WITHHOLDING

Taxpayers with earned income not subject to withholding may find that they qualify for the Making Work Pay Credit but have received no benefit from it until they claim it on their 2009 tax return. Taxpayers who are confident that they will qualify for the credit can consider reducing their 2009 estimated tax payments to reflect the credit and get some current benefit similar to that received by those with reduced withholding.

Taxpayers who change their status during the year, such as getting married or getting terminated and having an income projected to exceed the phase-out suddenly come to an end, are likely to find that the withholding taken from their paychecks was insufficient, and they can claim the additional credit amount when they file their tax return.

CHANGING THE W-4 AND W-4P

When taxpayers are identified who are subject to an under-withholding situation, the easiest step to take is probably to file a revised W-4 (W-4P for pensioners) to increase their withholding.

Rather than alter the number of exemptions claimed, the taxpayer can include an additional amount to be claimed on their paycheck on Line 6 of the W-4. Although the amount of the additional amount will vary with the frequency of the pay periods and whether the Making Work Pay Credit is totally or only partially eliminated, for a semi-monthly pay period starting April 1, an additional amount of $22 per pay period would equal approximately $400. The later in the year that the W-4 is adjusted, the larger the additional withholding should be to compensate for the earlier period when the under-withholding was occurring.

THE FUTURE

The Making Work Pay Credit will be around for 2010 also, but the withholding tables will probably be further revised to reflect a Jan. 1, 2010, starting date, rather than the delayed April 1 date used in 2009. The W-4 may then have to be adjusted again similarly to reflect the fact that the adjustment will impact the entire 2010 year, rather than just part of the year, as will be the case for 2009.

Finally, if the Making Work Pay Credit goes away in 2011, as it is currently scheduled to do, the tables will be revised upward and the W-4 will have to be amended again to eliminate the additional withholding.

Although a lot of effort may be involved in making these minor adjustments, tax practitioners will at least not face clients unexpectedly presented with tax penalties for under-withholding.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.

(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.

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