In today’s tight labor market, small businesses may need to think outside the box to find employees to fill open positions. In some cases, you may have to sweeten the deal with higher salaries or extra benefits. But you may be able to offset higher compensation costs with a lucrative federal tax credit for hiring members of certain “targeted” groups. Here’s what employers should know to take advantage of the Work Opportunity Tax Credit (WOTC).
The WOTC can only be claimed for hiring and paying a member of one of the following targeted groups:
- Qualified recipients of aid to families with dependent children or a successor program,
- Qualified veterans,
- Qualified ex-felons,
- Designated community residents,
- Vocational rehabilitation referrals,
- Qualified summer youth employees,
- Qualified supplemental nutrition assistance benefits (food stamp) recipients,
- Qualified Supplement Security Income (SSI) recipients, which includes anyone who’s certified by the designated local agency as receiving SSI benefits for any month ending within the 60-day period ending on the hiring date,
- Long-term family assistance recipients, and
- Qualified long-term unemployment recipients.
Before you can claim the WOTC, eligible workers must be certified as a member of one of these groups.
General Rule for Quantifying Your Credit
The WOTC generally equals 40% 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 per eligible employee (40% times $6,000).
The credit rate is reduced to 25% of qualified first-year wages for an employee who completes at least 120 but less than 400 hours of service. That translates into a maximum credit of $1,500 per eligible employee (25% times $6,000).
Qualified first-year wages mean qualified wages paid for services rendered during the one-year period beginning with the day the newly hired employee begins work.
Favorable Exceptions to the General Rule
Special rules apply to certain veterans, summer youth employees, and long-term family assistance recipients. Specifically, these increased first-year wage limits apply to the following workers:
|Type of employee
|First-year wage limit
|Maximum credit per eligible employee
|Qualified veteran who’s entitled to compensation for a service-connected disability and was discharged or released from the military within the last year
|Qualified veteran who was unemployed for at least six months in the prior year
|Qualified veteran has both a service-connected disability and was unemployed for at least six months in the prior year
|Qualified summer youth employee who is 16 or 17, lives in an empowerment zone and is paid during any 90-day period from May 1 to September 15
|Long-term family assistance recipient
In addition, for a long-term family assistance recipient, the WOTC can be claimed for 50% 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 per eligible employee (50% times $10,000) — and a maximum combined credit for the two years of $9,000 ($4,000 plus $5,000).
Side Effects of Claiming the Credit and Limitations
Employers that claim the WOTC must reduce their federal income tax deduction for the related wages dollar for dollar. But that outcome can be avoided by not claiming the WOTC if deducting the wages gives a better tax result.
Wages that were taken into account to claim the COVID-19-related employee retention tax credit couldn’t be used to claim the WOTC. In addition, the WOTC can’t be claimed for an employee who’s related to the employer or to certain owners of the employer, or for any employee who was previously employed by the employer.
Moreover, the WOTC can’t be claimed 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 also don’t qualify for the WOTC.
Claiming the Credit
Your tax advisor can help you calculate and claim the WOTC. This is one of the credits that comprise the General Business Credit and is, therefore, subject to the limitation rules for that credit.
Any unused WOTC amount for the year can be carried back one year. Any still-unused amount for the year can be carried forward for 20 years. If there’s still an unused credit amount after the 20-year window closes, it can usually be deducted in the 21st year.
Use It or Lose It
It’s easy for busy small business owners to overlook the WOTC, but this can be a costly mistake. It pays to remember to ask potential new hires the questions necessary to determine if they’re a member of a targeted group. If you hire someone who qualifies for the credit, your tax professional can do the paperwork necessary to claim the WOTC.
|Certifying Eligible Employees
To be an eligible employee for purposes of the Work Opportunity Tax Credit (WOTC), a new hire must be certified as a member of a targeted group by the applicable State Workforce Agency (SWA). As the employer, you can either:
A simplified certification process is available for qualified unemployed veterans. Contact your tax advisor for more information.