Lock In Your Payroll Tax Cut

You probably received the benefit of the Making Work Pay Credit in the form of reduced payroll tax withholding and slightly bigger paychecks last year. But you don’t get to keep the credit -- which reduces your tax liability -- unless you claim it on your 2010 tax return.

And if your income or filing status makes you ineligible for the credit, you’ll have to give it back. That could mean getting a smaller tax refund or owing more tax when you file your 2010 return, which is due by April 18, 2011.

Most taxpayers must file Schedule M -- as in “money” or “migraine” -- to claim the credit, which is worth up to $400 for individuals and $800 for married couples filing jointly. If you file Form 1040EZ, you need to fill out the worksheet accompanying the form. (But if you use tax-preparation software, it will do the calculations and fill out the appropriate forms for you).

Self-employed workers, who often file estimated tax payments each quarter rather than having taxes withheld from their paychecks, are also entitled to the credit. Make sure you fill out Schedule M to claim it. If you did not adjust your quarterly payments to reflect the credit, you’ll get the full benefit when you file your taxes, as either a reduced tax bill or a bigger refund.

Not everyone qualifies

Some workers received the full credit through reduced payroll tax withholding even though they were not eligible. The credit is reduced for individuals with incomes of more than $75,000 and disappears completely at $95,000. For married couples filing jointly, the credit starts phasing out when their income reaches $150,000 and disappears completely at $190,000.

And anyone who can be claimed as a dependent on someone else’s return, such as a student who works part-time, is not eligible for the credit.

As a result, several groups of workers may face some unexpected problems when they tackle their 2010 tax returns. Individuals who held more than one job last year, for example, may have received more than the maximum $400 credit allowed per person. And some married couples with two working spouses may have received the benefit of the credit individually even though their combined income made them ineligible for the full credit.

Looking ahead

The Making Work Pay Credit disappeared at the end of 2010 and was replaced with a two-percentage-point reduction in the payroll withholding tax for everyone, regardless of income. That means all workers will enjoy the benefit of the payroll-tax holiday throughout 2011, and they won’t have to bother with Schedule M when they tackle their 2011 taxes next year.