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Making Work Pay Tax Credit

how does federal tax credit work

By William Perez. Tax Planning: U.S. Expert

William Perez has worked as a tax professional since 2004. He earned the enrolled agent designation by passing a comprehensive examination on federal taxes and maintains his credential by taking continuing education classes.

The Making Work Pay tax credit is a new tax credit worth up to $400. This tax credit is temporary and will be in effect for the years 2009 and 2010 only.

Earned Income Required for the Credit

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Earned income for the Making Work Pay credit means income from wages and self-employment.

There's two modifications here, though. Any net self-employment income that is not taken into account for taxable income is also not taken into account for the Making Work Pay credit. Also, any combat pay which is otherwise excluded from income is taken into account for the purpose of calculating the Making Work Pay credit.

Who's Eligible, and Who's Not Eligible

Only US citizens and resident aliens with a valid Social Security number are eligible for the Making Work Pay credit.

Anyone claimed as a dependent is not eligible for the credit. That means kids who are working, including college students who are still claimed as dependents, are not eligible for the credit. Because paycheck withholding is going to be adjusted by employers, working dependents may need to adjust the withholding manually to avoid owing tax at the end of the year.

Nonresident aliens, estates, and trusts also do not qualify for the Making Work Pay credit.

Revised Paycheck Withholding

The IRS has revised the tax

withholding tables so that taxpayers can see a tax benefit this year. Employers are required to implement the new withholding rates no later than April 1, 2009. Employees will not need to do anything to take advantage of the new withholding rates. You will not need to fill out a new Form W-4 to adjust your withholding .

However, individuals and couples with multiple jobs may need to adjust their withholding to have more taxes taken out if they expect not to qualify for the tax credit based on their total income. Similarly for working dependents (who are not eligible for the credit) or working retirees (who may be eligible for a reduced credit).

Self-employed persons could take advantage of the credit now by reducing their estimated tax payments. Since the credit is worth $400, estimated payments could be reduced by $100 per quarter.

Will Still Need to Claim the Credit on Your Tax Return

The Making Work Pay tax credit will need to be claimed on the 2009 and 2010 tax returns to ensure that the amount of the credit is properly calculated. This is true even though tax withholding is being adjusted now to reflect this new tax credit. The IRS explains it this way, "Though all eligible taxpayers will need to claim the credit when they file their 2009 income tax return next year, the benefit will generally be spread out over the paychecks they receive beginning this spring and continue until the end of the year." (Source: IR-2009-13 )

Taxpayers will use new Schedule M for calculating the Marking Work Pay credit.

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