A Tax Fact from The Tax Institute at H&R Block

Mid-year has traditionally been a good time to give your W-4 a checkup. And, this year, with the ‘Making Work Pay’ credit and revised withholding tables, it’s more important than ever that you review your withholding so you don’t have an unpleasant surprise (smaller refund or a bigger balance due) when you complete your return in January 2010. More on this later.

The big question, ‘why review your W-4?’
First, you may want your withholding to result in as close to a zero balance due/refund as possible. That is, you want enough tax withheld from your paycheck so you don’t owe the IRS money at the end of the year, but you’d rather not give the IRS an interest-free loan on too much of your hard-earned cash. You might want to plan for a refund, or even just the right balance due so you won’t owe a penalty if you pay the balance in on time.

Under normal circumstances, you should always consider reviewing your W-4 if certain situations have occurred since you last completed your W-4 for your employer.

In your personal life, did you:

• Get married or divorced
• Add or lose a dependent
• Buy or sell a home
• Retire (but continue working part-time)

In the financial realm, did you experience changes to:

• Your investment income (e.g., interest, dividends, capital gains)
• Your earned income (e.g., if you or your spouse started or ended a job, got promoted)
• Other income (such as scholarship income and gambling and lottery winnings)
• Your deductions (such as medical or moving expenses)
• Your tax credits (such as the Earned Income Credit, Child Tax Credit, or Savers Credit)

Now, what about that ‘Making Work Pay’ credit?’
As part of the February 2009 American Recovery & Reinvestment Act (a.k.a 2009 Stimulus Act), which made approximately 95% of America’s working families eligible for a ‘Making Work Pay’ refundable tax credit of up to $400 for working individuals and up to $800 for working couples, the IRS revised the withholding tables used by employers and payers of pensions.

To receive early benefit of the credit, eligible employees didn’t have to do anything. Companies had until April 1 to institute the newly-revised withholding tables. Employees then began benefitting from the revised withholding tables, with larger take-home paychecks starting no later than April 2009. The revised withholding tables are for calendar years 2009 and 2010.

So what’s the problem?
The problem is that because the IRS withholding tables cannot take into account ineligible taxpayers, workers with multiple jobs, or dual-income married couples, the reduced withholding may actually exceed the credit that you’ll be able to claim when you file your tax return next year. And there’s more.

What if you elect to accept your adjusted withholding, but at the end of the year, you’re not eligible for the full credit – do you have to pay it back?
Well, yes. If your withholding was reduced by more than the credit to which you’re entitled to claim, you will effectively repay the difference by way of a reduced refund or a higher balance due. The Tax Institute at H&R Block is awaiting clarity regarding possible waiver of any underpayment penalty that results because of this change. Continue to check Digits for updates.

What determines if I qualify for the full benefit?
The tax credit is calculated at a rate of 6.2% of your earned income (or joint income if filing MFJ - Married Filing Jointly). If you earn at least $6,450 and are not phased out of the credit, you will claim a credit of $400. If your withholding was reduced by $400, you are “even” for the year. If your withholding was reduced by less than $400, you will effectively get the benefit of the rest of the credit when you file your return.

Eligibility for the ‘Making Work Pay’ credit starts to phase out for individuals with adjusted gross incomes over $75,000 and phases out completely at $95,000. For couples, the phaseout starts $150,000 and completely phases out at $190,000.

What if I’m self-employed and pay estimated taxes?
Eligible taxpayers who are self-employed can adjust their quarterly estimated tax payments to account for the ‘Making Work Pay’ credit. Care should be taken before doing so because self-employment income fluctuates, and a quarterly underpayment could occur even if you have a refund at the end of the year.

Still confused?
You’re not alone and that’s why the tax analysts from The Tax Institute at H&R Block have developed a ‘Making Work Pay W-4 Withholding Calculator’ to help. This calculator will help you estimate the overall reduction in your withholding due to this change compared to the credit you expect to claim on your return.

Do I have to accept the reduced withholding?
If after using the ‘Making Work Pay W-4 Calculator,’ you determine you don’t want your withholding reduced, either because you know the reduction in withholding will exceed the credit you’ll be able to claim or because you’d rather have the benefit in a lump sum with your refund when you file your 2009 return next year, you’ll need to file a new W-4 with your employer to request that your withholding be increased to the desired amount.  

Our June Blog:
Check out our June blog, 'Pay as You Go –or Else' and sound off about paying your taxes!!! We want to hear from you.

This Tax Fact is brought to you by The Tax Institute at H&R Block. 

To view other helpful tax information or listen to our Tax Fact podcasts, visit www.digits.hrblock.com

As always . . . everyone’s tax situation is different, so be sure to consult a tax professional or financial advisor before making important financial decisions.

This Tax Fact is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice, nor is it intended to be used to avoid IRS penalties.