Despite the declining unemployment rate, many veterans struggle to find jobs matching their education, skills and experience. In an effort to hire veterans and other individuals facing barriers to employment, the federal government established the Work Opportunity Tax Credit (WOTC) program – which rewards employers with a tax credit for each eligible new hire. Employers can reduce federal income tax by up to $9,600 per eligible hired employee, so it’s a good idea for employers to understand how the WOTC applies to their business.
In this Q & A, you will find relevant WOTC information, including target groups, eligibility requirements, how to calculate and claim credits, plus tips for getting the most out of the program.
What is the Work Opportunity Tax Credit (WOTC)?
Created in 1996, the WOTC has been modified and extended many times since. The program helps targeted individuals – such as veterans, welfare recipients, and ex-felons – find gainful employment. Ultimately, the goal is for these individuals to gradually shift from economic dependency to self-sufficiency by earning a steady income and paying taxes.
Employers may qualify for the WOTC when they hire an employee who meets the criteria for his or her target group. The credit can be taken only once for each eligible employee. According to the U.S. Department of Labor (DOL), employers claim more than $1 billion in tax credits each year under the program, which is administered by the Internal Revenue Service and the DOL’s Employment and Training Administration (ETA).
What are the WOTC target groups?
There are currently nine WOTC target groups:
- Long-term or Short-term Temporary Assistance for Needy Families (TANF) recipient
- Supplemental Nutrition Assistance Program (SNAP), or food stamps, recipient
- Designated community resident living in a federally-designated renewal community or empowerment zone
- Vocational rehabilitation referral
- Supplemental Security Income (SSI) recipient
- Summer youth employee living in a federally-designated empowerment zone
- Qualified long-term unemployment recipients – this group was later added by the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act).
Each group has its own eligibility requirements that the individual must meet in order for the employer to qualify for the credit. In addition, some employees automatically disqualify employers from getting the credit, such as relatives and dependents of the employer, former employees, and most business owners.
What are renewal communities and empowerment zones?
You may qualify for WOTC if have you employees living in renewal communities or empowerment zones, which are defined as distressed rural and urban areas with high levels of unemployment. The Urban and Housing Development’s address locator can help you identify employees living in a renewal community or empowerment zone.
How are the WOTC and PATH Act related?
Signed on Dec. 18, 2015, by President Obama, the PATH Act extends the WOTC program by five years, retroactive to Dec. 31, 2014 through Dec. 31, 2019; and reauthorizes the empowerment zones, until Dec. 31, 2016. As previously noted, the PATH Act also added qualified long-term unemployment recipients as a WOTC target group.
Is the WOTC mandatory or voluntary?
The program is voluntary. Employees who do not wish to participate must be allowed to opt out, without consequence.
How does the credit work for taxable employers?
You may take the credit once for each new hire identified as a member of a WOTC target group and who began or begins working for you after Dec. 31, 2014, and before Jan. 1, 2020. There is no restriction on the number of new hires who can qualify you for the tax savings. Because the credit is applied to your federal income tax liability, you must have an income tax liability to be able to use the credit – which cannot exceed the amount of income tax owed.
What if I don’t have a tax liability?
You can still apply for the credit, but you must have a tax liability to use it. Unused credits can be carried back one year, and carried forward on future tax returns for up to 20 years. It is therefore likely that you will be able to use the credit in the future, when you have a tax liability.
Are there special rules for tax-exempt organizations?
Qualified tax-exempt employers can claim the credit only for eligible veterans who began or begin working for the organization after Dec. 31, 2014, and before Jan. 1, 2020. The credit cannot be claimed for any other target group and must be applied against the organization’s share of Social Security tax.
How is the credit calculated?
The employee must work at least 120 hours during the initial year of employment for you to claim the credit, which is calculated as follows:
- For a new hire who works at least 120 hours in a year, you may claim a credit of 25 percent of first-year wages, up to the maximum credit for the target group.
- For a new hire who works at least 400 hours in a year, you may claim 40 percent of first-year wages, up to the maximum credit for the target group.
- For long-term TANF recipients, you can take a credit of 40 percent of first-year wages, up to the maximum credit, if the employee works at least 400 hours in the first year. For employees who work at least 400 hours in the second year, your credit is 50 percent of the second-year wages, up to the maximum credit.
Note that there is a cap on first-year and second-year wages. For example, for a SNAP (food stamp) recipient who works 400 hours in a year, the maximum credit is $2,400 because only the initial $6,000 of qualified wages can be considered. Depending on the target group, the maximum credit ranges from $1,200 to $9,600. You may use the WOTC calculator to estimate your total credit (Excel file download).
How do I apply for WOTC?
- Have the job applicant complete page 1 of IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, on or before the job offer date.
- Complete the employer section on page 2 of Form 8850 after the applicant is hired.
- Complete the U.S. Department of Labor Employment and Training Administration Form 9061, Individual Characteristics Form, if the employee does not give you an ETA Form 9062.
- Or fill out Part II of Form 9062, Conditional Certification, if the employee has been recognized as a member of a target group by a participating agency, such as the state workforce agency or a vocational rehabilitation agency. The employee can give you the form when hired or during the interview process.
- Send the completed and signed IRS and ETA documents to your state workforce agency within 28 days of the employee’s start date. Contact your state agency for submission guidelines.
What is transition relief?
Transition relief allows you more time to submit WOTC certification requests for target group employees hired since Jan. 1, 2015. In March 2016, the IRS issued Notice 2016-22, which established June 29, 2016, as the deadline for submitting applications for qualified employees hired between Jan. 1, 2015, and May 31, 2016. The IRS has since issued Notice 2016-40, which extends the deadline until Sept. 28, 2016, for qualified employees hired between Jan. 1, 2015, and August 31, 2016.
The extension allows you to:
- Screen employees after the job offer and start date.
- Identify eligible employees and retroactively capture WOTC credits.
Beginning Sept. 1, 2016, the necessary forms for all target groups must be submitted within 28 days of the new hire’s start date.
How do I file for and claim the credit?
After the state workforce agency certifies the target group employee, you can claim the credit as a general business credit against your income tax. Taxable employers must file the following with the IRS to claim the credit:
- Form 5884, Work Opportunity Credit
- Form 3800, General Business Credit
- Business income tax return.
Qualified tax-exempt organizations must claim the credit on Form 5884-C, Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans. In this case, the credit is claimed against your Social Security tax.
What are some best practices for maximizing the WOTC?
To get the full value of the program:
- Encourage participation by communicating WOTC benefits to job applicants.
- Stay abreast of legislative changes to avoid missing out on time-sensitive opportunities.
- Create a user-friendly screening process that enhances corporate culture. For example, offer an online platform that screens new hires via questionnaire and immediately captures the results.
- File all WOTC forms accurately and on time with the state workforce agency to avoid processing delays or denial of your application.
- Track WOTC key performance indicators (KPIs) to evaluate the program. KPIs can tell you the percentage of new hires screened and what percentage of paperwork sent to the state workforce agency resulted in approval.
- Simplify your workflow – including tracking hours and wages of potentially eligible employees – by leveraging technology that supports WOTC processing.
- Maintain proper records, including copies of certifications you receive from the state workforce agency and IRS Form 8850.
The WOTC offers a win-win solution for target group members and their employers. But, given the depth of knowledge needed to maximize WOTC benefits, employers should consider partnering with a WOTC consultant or CPA.