New Law: Time to Benefit from the Work Opportunity Tax CreditTax Planning
As you know, tax credits are the best.
Suppose your business hires a member of a targeted group. In that case, you can claim the potentially lucrative federal Work Opportunity Tax Credit (WOTC) for some of the wages paid to the individual.
Here’s what you need to know to make the WOTC a tax saver for your business.
The credit generally equals 40 percent 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 (40 percent x $6,000).
Of course, some employees don’t work out. The tax code recognizes that and reduces the credit rate to 25 percent of qualified first-year wages for an employee who completes at least 120 but fewer than 400 hours of service. That translates into a maximum credit of $1,500 (25 percent x $6,000).
“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
obtain the certification by the day the employee begins work, or
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 submit Form 8850 to the SWA (not to the IRS) within 28 days after the employee begins work.
Click here for links to the names, addresses, phone and fax numbers, and email addresses of the WOTC coordinators for each of the SWAs.
A simplified certification process is available for qualified unemployed veterans.
You can claim the WOTC only if you hire a member of a targeted group. Targeted groups include the following:
- Qualified IV-A recipients
- Qualified veterans
- Qualified ex-felons
- 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
Calculating the Credit
Here’s the drill.
As stated earlier, the WOTC generally equals 40 percent 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 (40 percent x $6,000).
As stated earlier, the credit rate is reduced to 25 percent of qualified first-year wages for an employee who completes at least 120 but fewer than 400 hours of service. That translates into a maximum credit of $1,500 (25 percent 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 was discharged or released from the military within the past year. That translates into a maximum credit of $4,800 (40 percent 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 (40 percent x $14,000).
If a qualified veteran both has 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 (40 percent x $24,000). Wow!
The WOTC for a long-term family assistance recipient equals 40 percent of qualified first-year wages, up to a maximum wage amount of $10,000. That translates into a maximum credit of $4,000 (40 percent x $10,000).
In addition, for long-term family assistance recipients, the WOTC can be claimed for 50 percent 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 percent x $10,000) and a maximum combined credit for the two years of $9,000 ($4,000 + $5,000). Another 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 percent 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 (40 percent x $3,000).
Side Effects and Limitations
As the employer, you’ll find that claiming the WOTC reduces your federal income tax deduction for the related wages dollar-for-dollar.
In the unusual circumstance where you would obtain a better result without the tax credits, you forgo the credit and simply deduct the wages.
Wages that you take into account to claim the COVID-19-related employee retention tax credit cannot be used to claim the WOTC. In other words, no double-dipping.
Also, you cannot claim the WOTC for an employee who is related to you, the business owner.
Finally, 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 do not qualify for the credit.
Claiming the Credit
Calculate and claim the credit on IRS Form 5884 (Work Opportunity Credit). The WOTC is one of the credits within the General Business Credit (GBC) and is subject to the GBC limitation rules.20 Carry the WOTC amount from Form 5884 to Form 3800 (General Business Credits), and take it from there.
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.
If you qualify for the WOTC, take it. It’s just about impossible not to come out ahead.
As you learned in this article, it works like this: Say you had WOTC wages of $100,000 and a credit of $30,000. You first offset your taxes by $30,000, and you then deduct the remaining $70,000.
This WOTC spent most of its legislative life on the extenders list, meaning that it was scheduled to expire every year or so (and sometimes did expire before being retroactively revived)—a nightmare for good tax planning. But now that the WOTC is in place through 2025, you can spend the time getting the hiring and compliance mechanics in place without having to worry about the credit expiring. That’s huge.