How the New Employment Credit Recapture Works

The New Employment Credit (NEC) is a California tax benefit for businesses that hire full-time employees in specific geographic areas. A feature of this program is the recapture provision, a mechanism that requires an employer to pay back a portion or all of the credit claimed. This clawback is triggered if the conditions of the employment are not met for a specified duration. The provision underscores the credit’s goal of fostering stable, long-term employment.

Recapture Triggering Events

The New Employment Credit is subject to recapture if the foundational terms of the qualified employment change within a specific timeframe. The primary trigger for this recapture is the termination of a qualified employee at any point during the first 36 months of employment. This 36-month period begins on the employee’s hire date.

The recapture is not limited to the credit claimed in the year of the triggering event. Instead, the employer is required to pay back the entire amount of the credit claimed for that specific employee for all prior taxable years. This comprehensive clawback emphasizes the long-term commitment expected from employers participating in the NEC program. The California Franchise Tax Board (FTB) enforces these provisions to maintain the integrity of the credit’s purpose.

Calculating the Recapture Amount

The amount of the New Employment Credit that must be recaptured depends directly on when the termination occurs. The recapture is calculated based on the total credit amount claimed for that employee in the current and all previous tax years. If a triggering event happens, the full credit amount attributed to that employee’s wages is subject to being paid back to the state.

For instance, if an employer claimed a $5,000 credit for a qualified employee in year one and a $6,000 credit in year two, and then terminates that employee without a valid exception during the first 36 months, the entire $11,000 would be subject to recapture. The recaptured amount is then added to the employer’s tax liability in the year the triggering event occurred.

This all-or-nothing approach within the 36-month window simplifies the calculation but also raises the stakes for employers. There is no partial recapture based on how long the employee worked within that period.

Exceptions to the Recapture Rule

Certain conditions allow an employer to avoid recapturing the New Employment Credit, even if a qualified employee’s job ends within the initial 36-month period. The recapture rule is waived in the following situations:

• The employee voluntarily leaves their position.
• The employee is terminated for misconduct, which refers to a willful or wanton disregard of the employer’s interests. This could include actions like theft, insubordination, or a substantial breach of company policy. The burden of proof for demonstrating misconduct often falls on the employer.
• The employee becomes disabled and is unable to continue performing their job duties, or in the event of the employee’s death.
• The employer’s business is sold or acquired by another company, and the new entity continues to employ the qualified individual under similar terms. This exception facilitates business transitions without penalizing employers for changes in ownership.

Reporting and Paying the Recapture Tax

The taxpayer is required to use Form FTB 3554, New Employment Credit, to report the recaptured amount. This form is the same one used to initially claim the credit, but it includes sections specifically for calculating and reporting the recapture.

The calculated recapture amount is added to the employer’s total tax liability for the taxable year in which the triggering event occurred. For example, if an employee is terminated in March 2025, the recapture amount will increase the tax owed on the 2025 state tax return. The completed Form FTB 3554 must be attached to the taxpayer’s annual California income tax return, such as Form 540 for individuals, Form 100 or 100S for corporations, or Form 565/568 for partnerships and LLCs.

It is important for taxpayers to accurately complete the recapture portion of Form FTB 3554. Failing to report a required recapture can lead to penalties and interest on the unpaid tax amount.