If you’re a business owner in California, you may be able to save money by stacking all the tax credits you qualify for. One of those tax breaks is the new employment credit (NEC), which incentivizes businesses to hire employees in high-need areas across the state. Qualification is based on the industry you’re in, where you’re located, and a few other factors. If you can clear those hurdles, the new employment credit can help your business save money.
What is California’s new employment credit (NEC)?
The new employment credit is a state income tax credit that California-based businesses can claim through 2025. To qualify for the credit, a business will need to hire at least one eligible full-time employee in an area with high unemployment or a high poverty rate. California has identified several of these regions—called “designated geographic areas”—around the state. The business owner will also need to register a tentative credit reservation for each employee.
Step 1: Check if your business qualifies
The business itself will first need to meet a list of eligibility requirements. The business must:
- be located in California within a designated geographic area (DGA),
- hire qualified employees on or after Jan. 1, 2014 (more on what a “qualified employee” entails below),
- make a tentative credit reservation,
- offer pay that’s at least 150 percent of the state’s minimum wage, and
- show a net increase in employees for the tax year.
The following industries are excluded from the tax credit unless they’re classified as a small business:
- Temporary employment agencies
- Retail establishments
- Food service establishments
- Theater companies and dinner theaters
- Casinos or casino hotels
Sexually oriented businesses, such as bars that provide nude-adult entertainment, are excluded from the tax credit, regardless of their designation as small businesses.
Step 2: Check if your employees qualify
Next, you’ll need to check whether any of your workers qualify for the tax credit. No matter how large your staff is, you may qualify for the tax credit if at least one of your workers meets eligibility requirements. “Qualified” employees are workers that:
- were hired after the DGA is designated,
- perform at least 50 percent of their services in the designated geographic area,
- receive starting wages that exceed 150 percent of California’s minimum wage, and
- are a salaried full-time employee or an hourly employee working at least 35 hours per week.
The employee will also need to fall into one of the following categories:
- Recently unemployed individuals
- Recently discharged veterans
- Recipients of the federal earned income tax credit in the previous tax year
- Convicted felons
- Recipients of CalWORKS or other local assistance programs
Step 3: Apply for a credit reservation
When you hire new employees, you’re required to report certain information to the California Employment Development Department. There’s an extra step involved if you’re looking to claim the new employment credit. Within 30 days of completing the new-hire report, you’ll also need to submit a Tentative Credit Reservation (TCR) online.
Make sure you have the necessary information, and head to the FTB website to complete the reservation. You should receive confirmation right away. For the five years you claim the credit, you’ll need to complete an annual certification of employment.
Step 4: Calculate your net employee change
The value of your tax credit is influenced by the total number of employees on payroll this tax year, the number of qualified employees, and their wages. You’ll also need to know how many employees were on payroll during your “base year,” which is the tax year right before you hired a new qualified employee for the tax credit.
For example, let’s say your base year is 2021 and you had 10 employees working for you. In 2022, you hired one new full-time qualified employee. When you file taxes in 2023, you can report that your workforce had a net change of one employee.
Because the number of employees meets or exceeds your base-year workforce, then you qualify for the tax credit. However, if you now have fewer employees compared to your base year, then your tentative credit will be reduced.
Step 5: Calculate the credit
If you’ve made it to this step, congratulations!
Now, you can figure out how much your business can claim. The tax credit is worth 35 percent of each qualified employee’s “qualified wages.” A qualified wage is the portion of pay that’s between 150 percent and 350 percent of California’s minimum wage. So for tax year 2023, you can claim 35 percent of wages that fall between $23.25 and $54.25.
For example, let’s say your full-time eligible employee earns $30 per hour. Here are the steps you can take to estimate how much the tax credit is worth for that employee:
Subtract the minimum hourly wage from the employee’s hourly wage to find the net hourly wage.
$30 – $15.50 = $14.50
Multiply the net hourly wage by the annual number of hours worked.
$14.50 x 2,000 = $29,000
Multiply that number by 35 percent.
$29,000 x 0.35 = $10,150
What you get is the tentative credit amount for that employee—in this example, it’s $10,150. Run this calculation for each qualified employee on your payroll.
Step 6: Claim the credit
If your business and at least one worker fits the eligibility requirements, you can claim the tax credit by filling out Form 3554 and attaching it to your business state income tax return. You can claim the credit for up to five years from the qualified employee’s hire date. If you terminate a qualified employee within the first 36 months after beginning employment, you may need to “recapture,” or pay back, some of the credit.
The tax credit can get complicated, especially when it comes to calculating the value of what you can claim. Talk with a tax expert or bookkeeper if you have questions about correctly claiming the NEC.