It’s not easy to hire workers these days. But if your business hires a member of a certain group, you can claim the potentially lucrative Work Opportunity Tax Credit (WOTC). Here’s what you need to know to make the WOTC a tax saver for your business.
Work Opportunity Tax Credit basics
This federal income tax credit generally equals 40% of qualified first-year wages paid to an eligible employee, up to a maximum wage amount of $6,000. That translates into a maximum credit of $2,400 per eligible employee (40% x $6,000). That helps.
The credit rate is reduced to 25% of qualified first-year wages for an employee who completes at least 120 but less than 400 hours of service. That translates into a maximum credit of $1,500 (25% x $6,000) per eligible employee. Not bad at all.
Qualified first-year wages means qualified wages paid for services rendered during the one-year period beginning with the day the newly hired employee begins work.
Special rules apply to certain veterans, long-term family assistance recipients, and summer youth employees. More on those special rules later.
To be an eligible employee, your new hire must be certified as a member of a targeted group by the applicable State Workforce Agency (SWA). You as the employer can either: (1) obtain the certification by the day the employee begins work or (2) complete a pre-screening notice, using IRS Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit), by the day you offer a job to a prospective employee. Then you submit Form 8850 to the SWA (not to the IRS) within 28 days after the employee begins work.
For links to the name, address, phone and fax numbers, and email address of the WOTC coordinator for each SWA, see here. A simplified certification process is available for qualified unemployed veterans.
Which employees are eligible for the Work Opportunity Tax Credit?
You can only claim the WOTC for hiring a member of a targeted group. Targeted groups include:
Qualified recipients of aid to families with dependent children or a successor program.
Qualified military veterans.
Designated community residents.
Vocational rehabilitation referrals.
Qualified summer youth employees.
Qualified supplemental nutrition assistance benefits recipients.
Qualified SSI recipients (anyone who is certified by the designated local agency as receiving Supplemental Security Income benefits under title XVI of the Social Security Act for any month ending within the 60-day period ending on the hiring date).
Long-term family assistance recipients.
Qualified long-term unemployment recipients.
See the instructions to IRS Form 8850 for plain-English definitions of these targeted groups.
Calculating the credit
Here’s the drill.
As stated earlier, the WOTC generally equals 40% of qualified first-year wages paid to an eligible employee, up to a maximum wage amount of $6,000. That translates into a maximum credit of $2,400 per eligible worker (40% x $6,000).
As stated earlier, the credit rate is reduced to 25% of qualified first-year wages for an employee who completes at least 120 but less than 400 hours of service. That translates into a maximum credit of $1,500 per eligible worker (25% x $6,000).
Exceptions to the general rule
There’s a higher limit of $12,000 for first-year wages paid to a qualified veteran who is entitled to compensation for a service-connected disability and who was discharged or released from the military within the last year. That translates into a maximum credit of $4,800 per eligible worker (40% x $12,000).
There’s an even higher limit of $14,000 for first-year wages paid to a qualified veteran who was unemployed for at least six months in the prior year. That translates into a maximum credit of $5,600 per eligible worker (40% x $14,000).
If a qualified veteran has both a service-connected disability and was unemployed for at least six months in the prior year, the limit for first year wages is $24,000. That translates into a maximum credit of $9,600 per eligible worker (40% x $24,000). Wow!
The WOTC for a long-term family assistance recipient equals 40% of qualified first-year wages up to a maximum wage amount of $10,000. That translates into a maximum credit of $4,000 per eligible worker (40% x $10,000). In addition, you can claim the WOTC for 50% of qualified second-year wages up to a maximum wage amount of $10,000. That translates into a maximum second-year credit of $5,000 (50% x $10,000) and a maximum combined credit for the two years of $9,000 ($4,000 + $5,000). Wow!
The WOTC for a qualified summer youth employee (a 16-year-old or 17-year-old who lives in an empowerment zone) equals 40% of first-year wages paid during any 90-day period between May 1 and September 15 up to a maximum wage amount of $3,000. That translates into a maximum credit of $1,200 per eligible youth (40% x $3,000).
Side effects and limitations to the Work Opportunity Tax Credit
As the employer, claiming the WOTC reduces your federal income tax deduction for the related wages dollar-for-dollar. You can avoid that outcome by not claiming the WOTC if deducting the wages gives you a better tax answer (not likely).
Wages that you take into account to claim the COVID-19-related employee retention tax credit (explained here) cannot be used to claim the WOTC.
You cannot claim the WOTC for an employee who is related to the employer (your business) or to certain owners of the employer or for any employee who was previously employed by the employer.
You cannot claim the WOTC for amounts paid under a federally funded on-the-job training program. Work supplementation payments under Section 482(e) of the Social Security Act reduce qualified wages. Wages paid to employees in strike replacement positions don’t qualify for the credit. The considerations mentioned in this paragraph are pretty unlikely to apply, but this is a full-service analysis.
How to claim the Work Opportunity Tax Credit
Calculate and claim the credit on IRS Form 5884 (Work Opportunity Credit). The WOTC is one of the credits that comprises the General Business Credit (GBC) and is therefore subject to the GBC limitation rules. Carry the WOTC amount from Form 5884 to Form 3800 (General Business Credits), and take it from there. Or have your tax pro handle the details.
You can carry any unused WOTC amount for the year back one year, and you can carry any still-unused amount forward for 20 years. If there’s still an unused credit amount after the 20-year window closes, you can usually deduct the unused amount in the 21st year. Personally, I’m not thinking too much about taxes 21 years from now, and I doubt you are either.
The bottom line
As you can see, the WOTC can be pretty lucrative. So, you don’t want to miss out if you hire an eligible worker. Ask potential new hires the questions necessary to determine if they are members of a targeted group. If they are, that’s a meaningful point in their favor.