If you’re preparing to hire new employees, you may be interested in the Work Opportunity Tax Credit (WOTC), which was recently extended through 2025.
Below, we’ll explain what the WOTC is, how it can help your business, and what you need to do to apply.
What is the Work Opportunity Tax Credit?
The WOTC is a federal tax credit available to employers who hire individuals from certain groups. The credit was created in 1996 to incentivize employers to expand their applicant pools and hire people who’ve historically had a tougher time finding work.
Over the course COVID-19 pandemic, many small businesses in America have been suffering. In response, the federal government has released legislation to establish new tax credits and expand existing ones in order to provide businesses financial relief during this challenging time.
The government recently reauthorized the WOTC and extended it until December 31, 2025, giving state workforce agencies over $18 million to support WOTC certification for fiscal year 2021.
As a business owner, the WOTC is a great opportunity to diversify your hires, save money on taxes, and help job candidates who’ve struggled during the coronavirus pandemic.
What are the qualifying groups?
To be eligible for the WOTC, you have to hire people who fall into one of the 10 qualifying groups, as defined by the IRS:
1. Qualified IV-A recipient: This refers to individuals who receive family assistance as part of a state plan under the Temporary Assistance for Need Families program.
2. Qualified veteran: There are a number of different veterans who qualify under the ROTC. They include:
- Veterans who receive help under the Supplemental Nutrition Assistance Program (SNAP) for at least three months during the first 15 months of their employment.
- Veterans who are unemployed for a total period of at least four weeks but less than six months in the one-year period before their hiring date.
- Veterans who are unemployed for a period of at least six months in the one-year period before their hiring date.
- Veterans who are disabled and entitled to compensation for their service-related disability; they must be hired no more than one year after being discharged or released from active duty in the U.S. Armed Forces.
- Veterans who are disabled, entitled to compensation for their service-related disability, and unemployed for a period totaling at least six months in the one-year period before their hiring date.
3. Qualified ex-felon: This refers to people who are hired within a year of being convicted of a felony or being released from prison for the felony.
4. Designated community resident: A designated community resident is anyone who is between 18 and 39 years old on their hiring date and lives in either an empowerment zone, an enterprise community, or a renewal community (we’ll explain what these are in detail later). The individual must continue to live in the location after they’re employed.
5. Vocational rehabilitation referral: This refers to anyone with a physical or mental disability who has been referred to an employer while receiving or after completion of rehabilitative services.
6. Summer youth employee: A summer youth employee must be at least 16 years old but under 18 on their date of hire or by May 1 of the year in which they were hired (whichever is later). They must live in an empowerment zone, enterprise community, or renewal community, and can only work from May 1 to September 15 (assuming they weren’t hired before May 1).
7. SNAP recipient: This refers to individuals who receive help from the Supplemental Nutrition Assistance Program, otherwise known as food stamps. To qualify, the person must be between 18 and 39 years old and be part of a family that received SNAP benefits for the previous six months or at least three of the previous five months.
8. Supplemental security income (SSI) recipient: This refers to anyone who received SSI benefits within 60 days of being hired.
9. Long-term family assistance recipient: This refers to individuals who are part of a family that received certain types of government assistance for specific periods of time.
10. Qualified long-term unemployment recipient: This refers to people who’ve been unemployed for no fewer than 27 consecutive weeks at the time of hiring, and who have received unemployment compensation during some or all of their unemployment period.
Keep in mind that you can’t take the tax credit for hiring family members who fall into one of the above categories. You also can’t apply the credit to former hires who are part of a qualifying group. They have to be WOTC-certified the first time they’re hired.
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Interested in other tax credits?
What are empowerment zones?
Certain qualifying individuals have to reside in empowerment zones, enterprise communities, or renewal communities, which are designated geographic areas that have high unemployment rates and poverty levels.
You can search your business’s location here to see if you operate within an urban or rural empowerment zone. As of the most recent data from the IRS, these are the states that currently have empowerment zones:
- New Jersey
- New Mexico
- New York
- North Dakota
- South Carolina
- South Dakota
- West Virginia
How to screen and qualify job applicants
In order to qualify for the WOTC, you have to screen your applicants before you hire them. Retroactive WOTC certification won’t work.
Here are the steps to follow:
- Download IRS Form 8850. There are two parts to the form: job applicant information and employer information.
- Ask your job applicant to fill out the first section of the form, ideally before you offer them the job, but no later than the day you offer them the job.
- Fill out the second section of the form no later than the day you offer the applicant the job.
- Once you complete the form, sign it and ask your job applicant to sign it, too.
- Download the Department of Labor Form 9061, which includes basic applicant and employer information.
- Fill out Form 9061 yourself using information from Form 8850, or ask your job applicant to fill it out directly. Whoever fills out the form needs to sign and date it.
- Submit Form 8850 and Form 9061 to your state workforce agency. Make sure to file the forms no later than the 28th calendar day after your hire starts working.
- Once you submit your forms, you have to wait to receive a determination from the state workforce agency.
How the tax credit works
If you qualify for the WOTC, you can apply the credit to your business income taxes (as long as you’re a taxable business). If you’re a qualified tax-exempt organization, you can apply the credit to your employer share of Social Security taxes.
The exact credit depends on a few factors, including the category of employee you hire, their salary, and the number of hours they work in a year. For most people you hire, you can take a maximum tax credit of 40 percent of their first-year wages up to $6,000—or $2,400 in a one-year period.
However, there are a few exceptions to the rule:
- For disabled veterans hired within one year of separation, the maximum tax credit is 40 percent on qualified first-year wages up to $12,000—or $4,800 for a one-year period.
- For disabled veterans who are unemployed for six months or more, the maximum tax credit is 40 percent on qualified first-year wages up to $24,000—or $9,600 for a one-year period.
- For unemployed veterans who are unemployed for six months or more, the maximum tax credit is 40 percent on qualified first-year wages up to $14,000—or $5,600 for a one-year period.
To qualify for the 40 percent credit, your employees have to work 400 hours or more within a year of being hired. If an employee works 120 hours but fewer than 400 hours, you can only apply a 25 percent tax credit to their first tax-year wages. Let’s look at an example to see how this plays out.
XYZ Incorporated, a taxable business, hires three employees from different qualified groups and pays them each $17 an hour. Employee 1 is a qualified ex-felon, Employee 2 is a designated community resident, and Employee 3 is a disabled veteran who’s been unemployed for 10 months.
In the first year, Employee 1 works 600 hours for a total of $10,200. You can apply the 40 percent tax credit to their first-year wages since they worked over 400 hours.
$10,200 x 40% = $4,080
However, because the maximum credit for Employee 1 is $2,400 for a one-year period, you can only take $2,400.
Let’s move onto Employee 2.
Employee 2 works 250 hours in the first year and earns a total of $4,250. Because Employee 2 worked more than 120 hours but fewer than 400 hours, you can only apply a 25 percent tax credit to their first-year wages.
$4,250 x 25% = $1,062.50
And now, to Employee 3
Employee 3 works 1,200 hours in the first year—which means you can apply the 40% tax credit—and earns a total of $20,400.
$20,400 x 40% = $8,160
You can take the full $8,160 because of Employee 3’s status.
For all three employees, your business can take a total of $11,622.50 in tax credits against your business income taxes. You can claim the WOTC for two years max. If you don’t take the full amount of credit, you can either carry it back one year or forward 20 years.
If you take the WOTC, be aware that you can’t use the same wages to qualify for other tax credits, like the Employee Retention Tax Credit or Employer Paid Family and Medical Leave Credit.
How to claim the tax credit
If you’ve already certified your job applicants, you’re halfway there. Once you submit Forms 8850 and 9061 to your state workforce agency and receive a positive determination, take the following steps:
- Wait until your employees have worked at least 120 hours in the first year to qualify.
- Fill out IRS Form 5884, which asks you to list your WOTC-certified employees’ hours and wages.
- Attach the form to your tax return.
- If you’re a qualified tax-exempt organization hiring a veteran, you need to fill out IRS Form 5884-C. Make sure you file it separately instead of attaching it to your tax return.
- Hold onto your information for at least five years. Keep records of all your WOTC documents, including job application forms, employee information, pay stubs, IRS forms, and approvals from your state workforce agency.
This article was originally published on September 26, 2017.