When delivering bad news to a taxpayer such as “you owe X dollars to the fed” or “Y dollars to the state” the question, if a refund was expected, is “ What happened, why is it different from last year”?

It would be nice to show them that their income rose putting them into a new tax bracket. This year that is rarely the case. I explain that Congress has replaced the “Making Work Pay” credit with a cut of 2% in their social security tax called the “Payroll Tax Cut”. To date, I have met one client who noted they saw more in their paycheck beginning in January 2011. All others never realized they were getting more in their paycheck and many state they would rather get the money as part of their tax refund because they just spend it during the year.

A little history… Making Work Pay (MWP) was part of the two-year stimulus package passed in 2009. It was targeted to lower income individuals with a credit of up to $400 for single wage earners and $800 for married wage earners. It phased out from $75,000 to 95,000 for single filers and double that for married couples.

When the Democrats first wanted to extend the MWP, the Republicans wanted to replace it with the Payroll Tax Cut taking your Social Security tax from 6.2% to 4.2% of income. The Payroll Tax Cut was eventually passed for 2011 and in December 2011 extended for two months and then in February 2012 a full year extension was voted on and passed.

NOTE: For those worried about Social Security going bankrupt, or might be going bankrupt… though the money is taken out of the Social Security Tax the Social Security money is replaced by funds from the General Accounting Fund. The cut does not impact Social Security funding. If this makes sense to you, dear reader, please call and explain it to me – talk slow.

How has this change affected our clients at VITA?

Using a filer with a “single” filing status:

Year to date our average VITA client’s income is $17,184. I’ve been involved in this program for eight years but I need to repeat that….average income is $17,184. More than half our clients are filing married or head of household. AVERAGE INCOME IS $17,184 !!

Last year the “single” client would have received $400 from MWP and this year received $343 with the reduced Social Security tax. A loss.

A taxpayer making $75,000 also would have received $400 MWP last year. This year they receive $1,500 with the reduced Social Security tax.

A taxpayer making $100,000 would have received $0 MWP last year. This year they received $2000.

Not quite the targeted goal to aid lower income that MWP had, is it?

For deficit fans the cost of Making Work Pay is $56 Billion compared to the Payroll Tax Cut cost of $116 Billion.

There was also a Democratic proposal to reduce the Social security tax to 3.1% which would have benefitted our client by $189 while the $100,000 client would have gotten another $1,100. This would have a cost of another $60 to $65 Billion.
It did not pass.

A Tax Policy Center analysis showed that replacing MWP with the Payroll Tax Cut has raised taxes on one-third of households (60% with income under $20,000).
A Citizens for Tax Justice report (November 30, 2011) shows that the expanded payroll tax cut proposed by Democrats would provide the wealthiest fifth of taxpayers with $83 billion while the poorest fifth receive just $7 billion.
Replacing the Payroll Cut with Making Work Pay would provide the wealthiest fifth with $13 B while providing the poorest fifth with $7 Billion.

One’s targeted, one’s not. One’s cheaper, one’s not. I type, you decide.

Now there are many who might like numbers (moi) others whose eyes have glazed over in paragraph 2. So lets bring this home with a real live example…

Two weeks ago I had a couple sit down for a quality review (after the preparer completes the return, it is checked for errors by another preparer). They had been in previously but had forgotten some medical costs, so I added that in. He works as a driver for a construction company. His income jumped by more than a third to just under $48,000. A good year but he expected his salary to drop back to $36k this year. Medical costs for his wife were over $7,000. Along with mortgage interest and real estate taxes they did not have more than the standard deduction in other words medical costs could not be written off. For 2011they owe $1,400 for to the Federal and another $300 to the state.

The gentleman put another piece of paper in my hand and said “Put the money in here”. It was his routing and account number. I explained that he wasn’t getting a refund and that he owed. He whispered to his wife and she started crying. He tells me that she feels responsible, as the medical bills are hers. He keeps repeating “but I pay my taxes every paycheck” interspersed with “we have never owed before”. We spent the next 15 minutes going over the tax return in detail. I showed him where the $800 from MWP would have been and explained his income jump moved him from a 10% tax bracket to a 14% bracket. He, like most, didn’t notice a bump in pay from the Payroll Tax Cut especially as his work hours vary from week to week.

As his wife kept softly crying saying it’s her fault, we talked about payment options as they had $1000 in the bank saved for his insurance due in April. In the end we all shook hands and they kept thanking me for the honesty, explanations and time. His last comment was “ we do everything right, we are honest, and now this”.

A couple making well above the average VITA income, careful of every dollar, spreading medical bills out evenly and paying them on time (medical is 25% of their take home pay!) and now an unexpected bill.

This isn’t the worse story I’ve run across, probably not even close. This couple has resources to make it and can move bills around to catch up in a year. The story is probably more a reflection of medical costs in the USA and how it impacts a family.

Their story does however illustrate a point.
I feel that we have taken a program (MWP) that wasn’t a budget buster (relative) and was targeted to working citizens on the lower end of the income scale and changed it/improved it/expanded it to a program that benefits those in which studies have shown save windfall money rather than spend it.

MWP was initiated as part of a stimulus package. Want to stimulate the economy? Give it to people who need to spend it, have to spend it and not those who might spend it but usually save it.