Tax Deal: 'Making Work Pay' Credit Out, Payroll Tax Cut In

Last Updated Dec 7, 2010 11:27 PM EST

The parsing of the tax deal reached between President Obama and Congress has focused on the two-year extension of the main features of the Bush-era tax cuts, including lower rates on earned income and much lower rates on dividends and long-term capital gains. Receiving less attention is one of the larger and more egalitarian tax breaks of the last two years, the "Making Work Pay" credit.

Whether or not the credit - worth $400 each year for individuals earning $75,000 or less, double for married couples filing jointly - would be extended was a subject of some consternation. Alas it was not part of the deal. There is something in the agreement to replace it, but whether taxpayers should feel better or worse or neither about it is up for debate.

The deal announced Monday calls for a reduction of two percentage points in the employee's portion of the payroll tax, taking it from 6.2 percent on the first $106,800 of earnings to 4.2 percent. Anyone making the maximum will save a hefty $2,136, and power couples who both make enough will pay $4,272 less.

If you're one of those high earners, you'll come out way ahead, but the advantage diminishes along with income, of course, so those on very modest salaries will be worse off. And after next year, everyone is due to be worse off. While the extension of the Bush-era tax cuts generally applies for two years, the payroll tax break in the agreement will be one and done in 2011.

In terms of fiscal impact, the two breaks are expected to be a wash. Brian Wingfield points out in his Forbes blog that "Making Work Pay" will probably end up costing $60 billion for each of its two years, while the 2011 payroll tax cut is projected to cost $120 billion.

All things considered, including the fact that "Making Work Pay" wasn't part of the Bush-era cuts, the payroll tax cut seems like a very good deal for many, probably most, taxpayers. Just don't forget to fill out Schedule M on Form 1040 by April 15 to claim "Making Work Pay" for 2010.