What Is a Work Opportunity Tax Credit and How Does It Work?

The Work Opportunity Tax Credit (WOTC) serves as a tax incentive to encourage employers to hire individuals from specific groups who face barriers to employment. By offering this credit, the program aims to expand hiring practices in ways that benefit both the workforce and the wider community.

Employer Eligibility Requirements

Employers must meet specific criteria to claim the Work Opportunity Tax Credit. They must be a taxable entity, such as a corporation, partnership, or sole proprietorship. Non-profit organizations can also qualify, but only when hiring eligible veterans, as outlined in the Internal Revenue Code Section 51.

To claim the credit, new hires must belong to one of the designated target groups defined by the IRS and Department of Labor. Employment must take place in the United States, and the employee must work at least 120 hours to qualify, with higher credits available for those working 400 hours or more.

Employers must submit IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, to the appropriate state workforce agency within 28 days of the employee’s start date. Maintaining accurate records, including documentation of employee eligibility and hours worked, is essential for compliance and substantiating claims.

Qualifying Employee Groups

The WOTC encourages hiring individuals from groups facing employment barriers. Employers must ensure new hires fall into one of these categories to qualify for the credit.

Veterans

Veterans are a key group eligible for the WOTC. The credit amount depends on factors such as unemployment duration prior to hire and service-connected disabilities. For instance, employers can claim up to $9,600 for hiring a veteran with a service-connected disability who has been unemployed for at least six months. This amount is calculated as 40% of the first $24,000 in wages. Required documentation includes discharge papers (DD214) and unemployment records.

Ex-Felons

Employers hiring ex-felons may qualify for up to $2,400 in tax credits. The credit is 25% of the first $6,000 in wages if the employee works at least 120 hours, or 40% if they work 400 hours or more. To qualify, the individual must have been convicted of a felony and hired within a year of release or the end of probation or parole. Documentation, such as court records or a parole officer’s statement, is necessary to verify eligibility.

Long-Term Unemployed

This group includes individuals who have been unemployed for at least 27 consecutive weeks. Employers can claim up to $2,400, calculated as 40% of the first $6,000 in wages. The employee must have received unemployment compensation during part of their unemployment period. Employers should retain records of the employee’s unemployment compensation from state agencies to validate their claim.

Calculating and Claiming the Credit

The WOTC is calculated based on wages paid to eligible employees and the applicable credit percentages. For most groups, the credit is a percentage of the first $6,000 in wages during the first year of employment, typically 25% for those working at least 120 hours and 40% for those working over 400 hours. For example, hiring an eligible employee who works 400 hours can yield a credit of up to $2,400.

To claim the credit, businesses file IRS Form 5884, the Work Opportunity Credit, along with their annual income tax return. The credit reduces the employer’s tax liability but cannot bring it below zero. If the credit exceeds the tax liability, it can be carried back one year or forward up to 20 years. Employers should understand how the WOTC impacts their tax positions, as it affects both current and deferred tax assets and liabilities.

Recordkeeping is critical. Employers must maintain documentation for each employee’s eligibility and hours worked, including IRS Form 8850 and supporting paperwork. Proper records ensure compliance and support claims in the event of an IRS audit.

Key Documentation Steps

Effective documentation is essential for managing compliance and maximizing the benefits of the WOTC. Employers should pre-screen potential hires to confirm eligibility and collect necessary information during the hiring process, including employee consent to access records verifying WOTC eligibility.

Timely submission of required forms is crucial. Employers must submit IRS Form 8850 to the state workforce agency within 28 days of the employee’s start date. This requires a streamlined process for collecting and submitting documents promptly. Staying informed about changes in documentation requirements from the IRS or legislative updates is key to maintaining compliance.