Millions may have to repay part of Obama tax credit

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For more than 15.4 million people, the Making Work Pay tax credit enacted as part of the $787-billion economic stimulus package could turn out to be a Making You Pay Back tax credit.

That’s the finding of a government watchdog report out today about the credit, which provides as much as $400 for individuals and as much as $800 for joint filers. It is the signature tax cut that President Obama promised in his campaign and was delivered with much fanfare in February.

The problem: In order to maximize the credit’s stimulative effect on the economy, withholding changes for taxpayers kicked in within days of Obama signing the legislation and taxpayers started seeing the changes in their paychecks in April. In essence, the credit was ‘advanced to taxpayers through their wages by a decrease in federal income tax withholding’ for the 2009 and 2010 tax years, according to the report by the Treasury Department’s Inspector General for Tax Administration.

If too much of the credit was advanced, a person would end up having to pay the extra money back. After analyzing 2007 tax return data, the Inspector General found that more than 15.4 million people could fall into that category this year. Among the reasons for having to pay back some of the credit are having more than one job or receiving pension or Social Security payments while still working.

The Internal Revenue Service said the report overstated the problem. The agency noted that about three out of four taxpayers receive refunds on their tax returns each year, averaging about $2,700 each. For most households, the withholding problem associated with the tax credit ‘means a reduced refund and not an out-of-pocket tax liability,’ the IRS said in a letter to the Inspector General.

[Updated at 1:42 p.m.: IRS spokesman Eric Smith said this afternoon that the agency would waive any underpayment penalty related to the tax credit. The agency is working on a waiver process for the approximately 65,000 people it said would face a penalty.]

[Updated at 9:15 a.m.: The Treasury Department put out its own statement on the issue. ‘Making Work Pay was designed to deliver much-needed boosts to the paychecks of 95% of all working Americans. Since enactment, more than 110 million families have benefited from as much as $60 in additional take home pay each month to put toward their family budgets -- serving as a steady boost to spending and consumption. The IRS has worked quickly and effectively to ensure that taxpayers received the benefit of this credit as soon as possible -- starting just days after the Recovery Act became law -- and will continue to do so going forward.’

-- Jim Puzzanghera