It is not easy to hire workers these days. But if your business hires a member of a certain group, you can claim the Potentially Profitable Work Opportunities Tax Credit (WOTC). Here’s what you need to know to make WOTC a tax saver for your business.
This federal income tax credit is generally equivalent to 40% of the eligible salary for the first year paid to an eligible employee, up to a maximum salary amount of $ 6,000. This translates to a maximum credit of $ 2,400 per eligible employee (40% x $ 6,000). Who helps.
The credit rate is reduced to 25% of the eligible salary for the first year for an employee who performs at least 120 but less than 400 hours of service. This translates to a maximum credit of $ 1,500 (25% x $ 6,000) per eligible employee. Not bad at all.
Qualifying first-year salaries are defined as eligible salaries paid for services rendered during the one-year period beginning on the day the newly hired employee begins work.
Special rules apply to certain veterans, long-term caregivers and young summer employees. More information on these special rules later.
To be an eligible employee, your new hire must be certified as a member of a targeted group by the applicable National Workforce Agency (SWA). As an employer, you can either: (1) obtain certification on the day the employee begins working or (2) complete a prequalification notice, using form IRS 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit), the day you offer a job to a future employee. Then, you submit Form 8850 to the SWA (not the IRS) within 28 days of the employee’s start of work.
For links to the WOTC coordinator name, address, phone and fax numbers, and email address for each SWA, see here. A streamlined certification process is available for qualified unemployed veterans.
Who are the employees eligible for the work opportunity tax credit?
You can only claim the WOTC for hiring a member of a targeted group. Target groups include:
Eligible beneficiaries of assistance for families with dependent children or of a successor program.
Qualified military veterans.
Designated community residents.
References in vocational rehabilitation.
Young qualified summer employees.
Eligible recipients of supplementary nutritional assistance benefits.
Qualified SSI Beneficiaries (any person certified by the local agency designated as receiving Supplementary Security Income benefits under Title XVI of the Social Security Act for any month ending within the 60-day period ending on the date hiring).
Beneficiaries of long-term family assistance.
Qualified long-term unemployment benefits.
See instructions for IRS Form 8850 for plain English definitions of these target groups.
Here is the drill.
As previously stated, WOTC is generally equivalent to 40% of the first year’s eligible salary paid to an eligible employee, up to a maximum salary amount of $ 6,000. This translates to a maximum credit of $ 2,400 per eligible worker (40% x $ 6,000).
As previously stated, the credit rate is reduced to 25% of the qualifying salary for the first year for an employee who performs at least 120 but less than 400 hours of service. This translates to a maximum credit of $ 1,500 per eligible worker (25% x $ 6,000).
Exceptions to the general rule
There is a higher limit of $ 12,000 for the first-year salary paid to a qualified veteran who is entitled to service-related disability compensation and who was demobilized or released from the military during the last year. This translates to a maximum credit of $ 4,800 per eligible worker (40% x $ 12,000).
There is an even higher limit of $ 14,000 for first-year wages paid to a qualified veteran who was unemployed for at least six months the previous year. This translates to a maximum credit of $ 5,600 per eligible worker (40% x $ 14,000).
If a qualified veteran both has a service-related disability and was unemployed for at least six months in the previous year, the limit for the first year’s salary is $ 24,000. This translates into a maximum credit of $ 9,600 per eligible worker (40% x $ 24,000). Wow!
WOTC for a long-term caregiver is 40% of the first year’s eligible salary up to a maximum salary amount of $ 10,000. This translates to a maximum credit of $ 4,000 per eligible worker (40% x $ 10,000). In addition, you can claim WOTC for 50% of the second year qualifying salary up to a maximum salary amount of $ 10,000. This translates to a maximum credit of $ 5,000 for the second year (50% x $ 10,000) and a maximum combined credit for both years of $ 9,000 ($ 4,000 + $ 5,000). Wow!
WOTC for a qualified young summer employee (a 16- or 17-year-old who lives in an empowerment zone) is 40% of the freshman salary paid for any 90-day period between May 1 and May 15. September up to a maximum salary amount of $ 3,000. This translates into a maximum credit of $ 1,200 per eligible youth (40% x $ 3,000).
Side effects and limits of the tax credit for the possibility of work
As an employer, applying for the WOTC reduces your federal income tax deduction for the corresponding wages, dollar for dollar. You can avoid this outcome by not claiming the WOTC if the salary deduction gives you a better (unlikely) tax answer.
The salaries you take into account to claim the COVID-19 Employee Retention Tax Credit (explained here) cannot be used to claim the WOTC.
You cannot claim WOTC for an employee who is related to the employer (your company) or 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 supplement payments under Section 482 (e) of the Social Security Act reduce eligible wages. Salaries paid to employees in strike replacement positions are not eligible for credit. The considerations mentioned in this paragraph are unlikely to apply, but this is a comprehensive analysis.
How to claim the work opportunity tax credit
Calculate and claim the credit on IRS Form 5884 (Work Opportunity Credit). WOTC is part of the credits that make up the General Business Credit (GBC) and is therefore subject to the GBC limitation rules. Carry forward the WOTC amount from Form 5884 to Form 3800 (General Business Credits) and take it from there. Or ask your tax professional to take care of the details.
You can carry forward any unused WOTC amount for the year back one year, and you can carry forward any unused amount for 20 years. If there is an unused credit amount left after the 20-year window closes, you can usually deduct the unused amount in the 21st year. Personally, I don’t think too much about taxes in 21 years, and I doubt you will either.
The bottom line
As you can see, WOTC can be quite lucrative. So, you don’t want to miss out if you hire an eligible worker. Ask potential new hires the necessary questions to determine if they are members of a target group. If they are, that’s an important point in their favor.