As part of the American Recovery and Reinvestment Act, the Making Work Pay Credit (the "Pay Credit") provides single and married taxpayers with a tax credit on their earned income in 2009 and 2010. The credit is provided through a decrease in the wage withholding tables, which increases the taxpayer's paycheck. The same withholding tables, issued in February 2009 and to be used starting April 1, 2009, apply to pension distributions, but the Pay Credit does not. As a result, pension checks have increased, but the pensioner's tax liability has not been reduced.
Some pensioners may have already filed a new IRS Form W-4P to increase their pension withholding as a result of the new lower withholding tables. For those who have not filed a revised Form W-4P, the result at the end of the year would be a greater tax liability than anticipated, in addition to possible underpayment penalties and interest due to under-withholding.
To remedy the situation, the IRS issued Notice 1036-P on May 14, 2009. This Notice provides plan administrators with the option of implementing a prospective adjustment to withholding on pension distributions to offset the reduced withholding resulting from the Pay Credit.
If the plan administrator adopts the new withholding procedures and implements the adjustments, the adjustments are automatic and do not require any action by a pensioner. No notice to pensioners is required.
However, a notice will avoid questions from pensioners who receive reduced pension checks, and it will also alert those pensioners who already filed a Form W-4P to increase their withholding to file another Form W-4P to avoid being over-withheld due to the automatic adjustment. Pensioners are required to be permitted to change withholding elections at any time before the next pension payment is made.
Even if the new adjustment procedure is not adopted for pensioners, employers and plan administrators should consider communications with employees and pensioners about the Pay Credit and the impact on tax withholding because employees and pensioners may wonder why their checks have increased. In addition, like pensioners, employees may find that they have not had sufficient taxes withheld at the end of the year. To avoid this result, a pensioner can file a revised Form W-4P and an employee can file a new Form W-4 to increase wage withholding.