Fed Tax Incentives: Work Opportunity Tax Credit
Background
The Work Opportunity Tax Credit (WOTC) is a federal tax credit (pursuant to IRC § 51) designed to benefit employers that hire individuals from target groups facing significant barriers to employment while also stimulating productivity and economic growth in the U.S.
In 2015, the WOTC was given a five-year extension through 2019, as part of the Protecting Americans from Tax Hikes Act of 2015 (Division Q of P.L. 114-113). The WOTC serves as a federal income tax credit intended as an incentive for businesses to hire individuals from certain targeted groups. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) retroactively allows eligible employers to claim the Work Opportunity Tax Credit (WOTC) for all targeted group employee categories that were in effect prior to the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014 and before January 1, 2020.
The Further Consolidated Appropriations Act of 2020 and the Taxpayer Certainty and Disaster Relief Act of 2019 ("2020 Tax Extenders") further provided a one-year extension to IRC § 51 (WOTC) and permits employers to claim a credit equal to 40% of qualified first year wages paid or incurred to a qualified individual who begins work for the employer before December 31, 2020.
The WOTC may potentially reduce an employer’s federal income tax liability by up to $9,600 per qualified applicant (depending upon the applicable employee target group), equal to a portion of the wages paid to those individuals. See IRC §51(a), (b).
An employer may claim a credit equal to 40% of an eligible employee’s qualified wages if the qualified employee worked at least 400 hours during the first year of employment, up to a statutory maximum. If the employee worked fewer than 400 hours but more than 120 hours, the employer may claim a credit equal to 25% of the employee’s qualified wages. If the employee worked fewer than 120 hours, an employer may not claim the WOTC. The WOTC is a nonrefundable tax credit, so an employer must have had tax liability to claim it.
The limit of wages that are WOTC eligible varies by the characteristics of the worker. The most common wage ceiling is $6,000 (for a maximum credit of $2,400 per employee), though some subpopulations are eligible for a higher or lower maximum. To claim the WOTC, an employer must have the employee certified as eligible by the appropriate state workforce agency. To do this, the employer submits a form to the state agency within 28 days of hiring the WOTC-eligible worker. The state agency determines that the individual meets the requirements and certifies the application. The employer may claim the credit as part of the General Business Credit. These credits can be carried back one tax year or carried forward up to 20 tax years
To be eligible for the credit, employers are required to timely file requests for certification with State Workforce Agencies (“SWAs”). Tax exempt employers that hire qualified veterans may claim this credit against Social Security taxes.
Eligible Worker Populations (max credit 40% of eligible wages)
This section describes the populations eligible for the WOTC under its most recent authorization. Note, since the WOTC was first enacted in the 104th Congress, the eligible populations have varied over the prior years.
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(1) Veterans (maximum WOTC-eligible wages of $6,000 to $24,000)
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(2) Temporary Assistance for Needy Family (TANF) Recipients (maximum WOTC-eligible wages of $6,000)
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(3) Long-Term TANF Recipients (maximum WOTC-eligible wages of $10,000 per year for up to two years)
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(4) Supplemental Nutrition Assistance Program (SNAP) Recipients (maximum WOTC-eligible wages of $6,000)
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(5) Designated Community Residents (maximum WOTC-eligible wages of $6,000)
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(6) Vocational Rehabilitation Referrals (maximum WOTC-eligible wages of $6,000)
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(7) Ex-Felons (maximum WOTC-eligible wages of $6,000)
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(8) Supplemental Security Income (SSI) Recipients (maximum WOTC-eligible wages of $6,000)
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(9) Summer Youth Employees (maximum WOTC-eligible wages of $3,000)
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(10) Long-Term Unemployed (maximum WOTC-eligible wages of $6,000)
Employer Benefits
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Depending on the target group of the new hire, an employer may reduce their federal income tax liability by up to $9,600 per each eligible employee hired.
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The credit offsets an employer’s cost for recruiting, onboarding, and training of new employees.
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There is no cap on the number of eligible people an employer can hire or the amount of tax credits that can be claimed each year.
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Private companies, C Corporations, S Corporations, LLC’s and even Non-Profit 501(c)’s can qualify.
Benefits for American Workers
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Supports workers who have consistently faced significant barriers to employment.
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Incentivizes workplace diversity and facilities access to jobs for American workers.
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Helps workers move from economic dependency into self-sufficiency.
Calculation of Credit and Maximum Credits
The amount of the WOTC is calculated as percentage of qualified wages paid to an eligible worker during the eligible employee’s first year of employment. In limited cases, an employer may claim the credit over two years.
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An employer may claim a credit equal to 40% of the eligible employee’s qualified wages if the eligible worker works at least 400 hours during the first year of employment. See 26 U.S.C. 51(i)(3).
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If the eligible employee works fewer than 400 hours but at least 120 hours, the employer may claim a credit equal to 25% of the eligible employee’s wages.
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If the eligible employee works fewer than 120 hours, an employer may not claim the WOTC.
For example, the maximum eligible wages for a qualified ex-felon is $6,000, so the maximum credit for an employer that hired such an individual would be 40% of $6,000 or $2,400.
Mechanics of Claiming the WOTC (Pre-screening and Certification)
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An employer must obtain certification that an individual is a member of the targeted group, before the employer may claim the credit. An eligible employer must file Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, with their respective state workforce agency within 28 days after the eligible worker begins work. Individuals’ eligibility for the WOTC is determined by state workforce agencies (SWAs). Employers should contact their individual SWA with any specific processing questions for Forms 8850.
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The employer also completes the individual characteristics information (ETA Form 9061).
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An eligible group member also obtains a conditional certification (ETA Form 9062) from a participating state or local agency. The jobseeker may then use it to market himself or herself to an employer.
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The employer completes a prescreening/certification request (IRS Form 8850) by the date a job offer is made and mails both the IRS and Employment and Training Administration (ETA) forms to the state’s WOTC coordinator within 28 days after the new hire starts working.
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States then verify that an individual is a member of a covered group and notify the employer that the application has been certified. States receive grants from Department of Labor (DOL) to support the administrative costs of processing WOTC certifications. Once a new hire is certified, the employer may claim WOTC as part of the General Business Credit.
Eligible Employers - Limitations on the Credits
WOTC is a nonrefundable credit. In general, the credit is limited to the amount of the business income tax liability or social security tax owed. A taxable business may apply the credit against its business income tax liability, and the normal carry-back and carry-forward rules apply. As such, the WOTC can be claimed in a tax year subsequent to the year of hire, it is possible that an employer that hires a WOTC-eligible worker, but does not have tax liability in the year in which the eligible worker was hired, would be able to have the WOTC applied to a subsequent tax year in which the employer has tax liability.
(1) Taxable Employers
After the required certification is secured, taxable employers claim the tax credit as a general business credit on Form 3800 against their income tax by filing the following:
(1) Form 5884 (with instructions)
(2) Form 3800 (with instructions)
(3) Your business’s related income tax return and instructions (i.e., Forms 1040, 1041, 1120, etc.). Employers generally have three years starting from the due date for filing a tax return to claim the WOTC. See IRS Instructions for Form 3800.
(2) Tax-exempt Employers
Qualified tax-exempt organizations described in IRC Section 501(c) and exempt from taxation under IRC Section 501(a), may claim the credit for qualified veterans who begin work on or after December 31, 2014, and before January 1, 2020. Tax-exempt organizations that employ WOTC-eligible veterans may be eligible to claim a credit against the organization’s payroll tax liability. This provision is limited to organizations that employ qualified veterans and does not apply to tax-exempt organizations that employ other WOTC-eligible populations.
After the required certification (Form 8850) is secured, tax-exempt employers claim the credit against the employer social security tax by separately filing Form 5884-C, Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans.
File Form 5884-C after filing the related employment tax return for the period that the credit is claimed. The IRS recommends that qualified tax-exempt employers do not reduce their required deposits in anticipation of any credit. The credit will not affect the employer’s Social Security tax liability reported on the organization’s employment tax return.
For qualified tax-exempt organizations, the credit is limited to the amount of employer social security tax owed on wages paid to all employees for the period the credit is claimed.
See IRS Link for additional background: