Last spring, Congress passed the American Recovery and Reinvestment Act of 2009 with provisions designed to stimulate the economy, including the Make Work Pay Credit (MWPC). The idea was to put more money into the pockets of individuals by way of their paychecks. But because of the unusual way the credit is administered, the Treasury Inspector General for Tax Administration (TIGTA) warned that instead of benefitting, some taxpayers will find themselves owing federal taxes and possibility penalties. That concern triggered a TIGTA review.
How the credit works
The MWPC advances money to taxpayers by decreasing the amount of federal taxes withheld from their paychecks. The maximum for this refundable credit is the lesser of 6.2 percent of earned income or $400 for single taxpayers ($800 for married-joint filers). While single filers would see $400 additional over a period of time in their paychecks, joint filers would ultimately see $600 in their paychecks, and upon filing their tax returns, qualify for another $200. Eligibility phases out for individuals earning $75,000 or more ($150,000 for joint filers).
Unlike most credits which are paid out by the IRS, the MWPC is administered at the employer level, through payroll. The Department of the Treasury created new withholding tables and provided them to employers to be used instead of the previously issued 2009 withholding tables.
TIGTA’s concern with the MWPC was that using one set of new withholding tables for all taxpayers would result in many individuals getting too much credit. The tables, say TIGTA, do not account for the various ways taxpayers adjust their withholding. Employees with very little leeway – for example, those who are claimed as dependents on the returns of their parents – could end up underpaying their federal taxes and possibly owing penalties. To explore the issue, TIGTA developed computer programs to identify at-risk groups.
The groups who were determined to be vulnerable include:
· Single taxpayers with more than one job
· Joint filers where one or both spouses have more than one job or both spouses work
· Individuals who file a return with an Individual Taxpayer Identification Number
· Taxpayers who receive pension payments
· Social Security recipients who receive wages
Using actual data from the 2007 tax year, TIGTA was able to estimate how many taxpayers in the above groups would end up owing taxes (and possibly penalties) for 2009 or who would get small refunds but would have owed taxes if the new tax tables had not been used. The results are that TIGTA estimates 15.4 million taxpayers (about 10.4% of all those filing returns) could suffer negative effects by using one set of withholding tables for all tax scenarios.
Specifically, the computer programs turned up these results:
· More than 1.6 million taxpayers who are claimed as dependents by other taxpayers could be negatively affected, as well as
· More than 2.5 million single taxpayers holding more than one job
· More than 4.1 million joint filers who worked the full year
· More than 87,000 filers using ITINs (the credit is only available for taxpayers with valid Social Security Numbers).
· More than 6.3 million pension recipients
· And more than 687,000 individuals who receive Social Security payments and are employed
In most of the categories above, the tax concerns are exacerbated if taxpayers hold more than one job.
“While implementing a credit through reduced withholding is an effective way to provide economic stimulus evenly throughout the year, it is difficult to account for everyone’s circumstances,” said J. Russell George, the Treasury Inspector General for Tax Administration. “More than 10 percent of all taxpayers who file individual tax returns for 2009 could owe additional taxes because their withholdings were reduced by more than the Making Work Pay Credit. If corrective actions are not taken, this problem will continue to plague taxpayers in 2010,” he added.
What “corrective actions” did TIGTA suggest?
First, they recommend that the Commissioner of the Wage and Investment Division of the IRS employ targeted advertising to inform those individuals who might be adversely affected that receiving the credit could cause them to owe taxes and penalties. The tax agency agreed with this recommendation. In response, the IRS created an outreach team, whose mission was to educate targeted groups about the potential tax implications of MWPC. For several months the team issued alerts using various means including the IRS Newswire, and even posting a video on YouTube.com.
TIGTA then followed up by polling members of the targeted groups and found that individual members of those groups had not gotten the message and did not know they were at risk. It was determined that the efforts of the outreach team were largely ineffective.
TIGTA’s second recommendation was that the IRS should allow pension administrators to use the withholding tables that were in effect before the new tables were issued, in order to protect pension recipients from the negative effects of the credit. The IRS disagreed. They stated that providing additional sets of withholding tables would be “burdensome, costly, and confusing for the IRS, taxpayers, and employers.”
The conclusion of TIGTA’s report is that in spite of efforts to educate individual taxpayers, more than 10 percent of the all filers could suffer negative consequences for having received the credit, and more than 1.2 million could be required to pay back some of the advance as well as be assessed penalties as a direct result of the MWPC.