Making Work Pay Credit

For the past couple of months, you’ve probably noticed a little extra money in your paycheck. Those extra few dollars are thanks to the Making Work Pay Credit which was part of the American Recovery and Reinvestment Act of 2009 signed into law by President Obama in February.

While you’re no doubt grateful for the extra cash, you may be wondering exactly how this works. The Making Work Pay Credit is administered through a reduction in wage withholding and provides up to $400 per individual worker and $800 per working married couple. However, this credit phases out for individuals whose modified adjusted gross income (MAGI) exceeds $75,000 or $150,000 in the case of married couples filing jointly.

The amount of credit you receive will be reported on your 2009 income tax return, but it’s not taxable and you won’t have to pay it back if you received the correct amount. If, for some reason, you do not have taxes withheld this year, you can claim a lump sum credit on your 2009 return.

Since these changes will be made automatically through your withholding, most taxpayers can sit back and relax and enjoy the additional spending money. However, there are potential problems for some taxpayers and we don’t want you to be caught off-guard.

For instance, if you are claimed as a dependent on someone else’s return, you do not qualify for the Making Work Pay Credit. College students, in particular, need to be aware of this restriction. These taxpayers will have to return any credit paid to them — either through a payment to the IRS or through a reduced refund.

Married couples who both work should also be very careful about “over withholding”. This can happen if each spouse’s employer makes the adjustment, but the couple’s combined income hits the phase out amount. If this is the case, make adjustments now so that you don’t have a problem next April. Either adjust your form W-4 or set money aside.

It’s also important to note that only individuals with earned income qualify for the Making Work Pay Credit. If you do not have earned income, you are not eligible for the credit.

To be sure that you don’t have any unpleasant surprises when you’re filing your 2009 tax return, it’s a good idea to take a look at your withholdings now. The few minutes it will take to do this could save you headaches down the road. Then, if you’re still concerned, make adjustments now or talk to your tax professional.

One more suggestion from the Lange team — if you are in a position to save rather than spend the credit, you may want to consider using that money towards covering the taxes on a Roth IRA conversion. Let’s take the example of a married couple in the 15% tax bracket. They qualify for both the Make Work Pay Credit and a Roth IRA conversion. Assuming they have IRAs, they could do a $5,000 Roth IRA conversion and use the $800 tax credit to pay the $750 of federal income taxes due on the conversion (with $50 left to treat themselves to dinner).