From Jim McGreevy: New Tax Tables Pose Potential Problem for Retirees

From Jim McGreevy, March 26, 2009

Subject: Additional STRS News

No sooner had I sent out my report on the March STRS Board meeting than two new items of interest came to light that I need to pass on to you.

- Jim

New Tax Tables Pose Potential Problem for Retirees

As part of the ARRA (American Recovery and Reinvestment Act), otherwise known as the “economic stimulus plan,” the IRS recalculated the income tax withholding charts for all employers and, as it turns out, all pension systems. The National Education Association (NEA) monitors pension issues and emailed the following:

The Internal Revenue Service has issued new tax withholding tables to reflect the Making Work Pay credit on earned income that was contained in the American Recovery and Reinvestment Act. While pension benefits are not considered earned income and NOT subject to the Making Work Pay credit, IRS nevertheless instructed the payers of retirement benefits to use the new federal withholding tables. Unfortunately, this likely will result in under-withholding on pension income, and retirees, most of whom are on a fixed income, may find themselves unexpectedly owing taxes at the end of the year.

Background

The Making Work Pay Credit called for by the Act applies to earned income and does not apply to retirement income. Most retirees instead receive an Economic Recovery Payment, which offsets the Making Work Pay credit for those eligible for both. Accordingly, logic would dictate that pension payers should simply continue withholding taxes from retirement benefits without regard to the credit since it does not apply to such income. Despite raising this issue with officials at the Treasury Department and the Internal Revenue Service, the Internal Revenue Service issued Publication 15-T this week with the following statement in the introduction: "For the calculation of income tax withholding on pensions, the new withholding tables also apply."

Issues Raised

If the IRS does not modify its position on this matter, benefit payers, acting on the new IRS directive, will begin withholding using tax tables that are known to be inappropriate for most retirees. While pension payers have indicated they will do everything possible to notify retirees of the reason for the change in the net amount of their benefit payment and the potential for under-withholding, the only way benefit recipients can change the withholding amounts is to proactively instruct their pension systems to increase the amount of their withholding, which is ripe for confusion and not easily calculated. Furthermore, at the close of 2010, they will have to readjust their withholding to reflect the fact that the tables for 2011 will no longer incorporate the making work pay credit.

Thus, to avoid confusion and possible back taxes being owed by retirees, it is believed that the better solution would be for IRS to allow the use of the old tables for income that is not eligible for the Making Work Pay Credit.

Congress and the Administration ought to strongly encourage the Internal Revenue Service to reconsider their position on this matter and allow pension benefit payers not to use the new federal withholding tables and instead use the old federal withholding tables. Using the old federal withholding would likely eliminate the potential that retirees on a fixed income will unexpectedly come up short next tax season.

NEA Action

NEA is actively involved with AFSCME, the National Council on Teacher Retirement, National Association of State Retirement Administrators, and AARP urging the IRS to use the old federal withholding tables. We are presently working with AFSCME on a letter to send to the Obama administration urging the IRS to use the old withholding tables. In addition, NEA and its coalition allies are actively lobbying Congress and the Administration to take action averting potential problems with the "Make Work Pay Credit" and retiree pension recipients. Our coalition partners ought to be meeting soon to discuss how best to communicate this issue to our retiree members. We will likely engage with other retiree organizations and the respective state pension systems that are charged with administering retiree federal withholdings on a communications strategy.

Thanks so much.

-Al

Alfred Campos

Federal Lobbyist

National Education Association

1201 16th Street, NW

Suite 510

Washington, DC 20036

To follow up on this information I contacted Laura Ecklar at STRS and received the following email in reply:

One of the key provisions of the stimulus package is the new "Making Work Pay" tax credit, which provides a refundable tax credit of up to $400 for working individuals and $800 for working families for 2009 and 2010. This tax credit will be calculated at a rate of 6.2% of earned income, and would phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 for married couples filing jointly). Taxpayers can receive this benefit through a reduction in the amount of income tax that is withheld from their paychecks, or through claiming the credit on their tax returns.

Pension plan distributions are not considered to be "earned income" for purposes of qualifying for this new credit. However, the Department of the Treasury issued new tax withholding tables to reflect the Making Work Pay credit and other changes resulting from the stimulus package and told pension plans, like STRS Ohio, to use the new tables.

As a result, the benefit payments to STRS Ohio members in April 2009 will reflect the new withholding tables. Since pension income is not subject to the new credit, such withholding could increase the likelihood that these individuals will owe taxes and possibly penalties at the end of the year. On the April 2009 check memos to our benefit recipients who have federal withholding, we will be informing them of the changes in the tax withholding tables, and how to change their withholding if they want to do that. We are also advising them to consult a professional tax advisor or more information, as STRS Ohio cannot provide advice.

As you can see from Laura’s response, you can expect to hear from STRS in the near future about this matter. Neither I nor STRS can provide you with advice on how to handle this issue. I recommend that you consult a financial advisor or tax preparer in the near future to see how your tax liability for 2008 will be affected so that you can be ready to take appropriate action in a timely fashion.