The Work opportunity tax credit is a business tax credit that, in some ways, is different from other credits, and therefore, I thought it would be helpful to discuss it. As I always say, tax credits are every business owner’s friend when it comes to saving money by reducing income taxes owed. Another crucial point I always mention about tax credits is that tax credits are not tax deductions; there is a difference. Tax deductions reduce taxable income, while tax credits reduce income taxes owed.
What is The Work Opportunity Tax Credit (WOTC)?
WOTC is a tax credit offering significant tax benefits to small businesses hiring employees from targeted groups. It is a Federal program that is administered at the state level. An estimated 21% of Americans are eligible for the credit. This means that if your business is not currently taking advantage of the credit, you should keep reading to find out if you qualify and if you do, get with your accountant and get set up to start taking the credit. The credit is set to expire in December 2025; that could change down the road if an extension is made.
Purpose of WOTC
The tax credit, enacted in 1996, incentivizes workplace diversity and provides opportunities for good jobs for the public.
Requirements
To receive the credit, an employer needs to start tracking hours worked right from the time of hiring a qualified employee. Unfortunately, credit cannot be given for the hours worked by existing employees (the rule is slightly different for tax-exempt organizations.) Taxable and tax-exempt employers can take the credit if they meet the tax credit requirements.
The new employee must be pre-screened to ensure she is eligible for the credit. The IRS states,
“An employer must pre-screen and obtain certification from the appropriate Designated Local Agency (referred to as a State Workforce Agency or SWA) that an employee is a member of a targeted group to claim the credit. To satisfy the requirement to pre-screen a job applicant, on or before the day that a job offer is made, a pre-screening notice (Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit) must be completed by the job applicant and the employer.”
Once SWA approves an employee, the employer can track the hours worked (going back to the first hour worked at hire.) The employee will need to work at least 120 hours in order for the business to start earning tax credits. The tax credits for an employee cease once the employee reaches the maximum allowed tax credit.
How Much of the Tax Credit Can Be Applied
The tax credit is computed as,
Employee Pay Rate X 0.25 X Hours Worked* = Earned Tax Credit
Once the employee crosses over to her 400th hour of work, the formula changes to:
Employee Pay Rate X 0.40 X Hours Worked* = Earned Tax Credit (until maximum credit is earned)
* goes back to the first hour earned
Unlike various other business tax credits that are paid out to a business, the WOTC is applied directly against a business’s tax liability as a general business credit (for taxable businesses) or against the business’s Social Security tax (for tax-exempt organizations.) What if your business has no tax liability for a given tax year? The tax credit can be rolled forward indefinitely until it is used up. See instructions for Form 5884, Form 5884-C, and Form 3800.
An Ideal Small Business for the WOTC?
A small business that is currently or continuously hiring individuals who hit the targeted groups or who have, or might have, a tax liability. Not only does the company reduce its overall taxable income (in the case of taxable businesses), but it also gets to give back to a community that is in need so it can develop and remain above the poverty line. It is a win-win for everyone.
The rules and calculations for the WOTC tax credit can be highly confusing, especially around the rules and exceptions. Therefore, it is strongly advisable to seek the assistance and expertise of a CPA or tax accountant.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult an experienced adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
