How Does the Work Opportunity Tax Credit Work?

Work Opportunity Tax Credit Explained

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The Work Opportunity Tax Credit (WOTC) program is a federal tax credit available to employers if they hire individuals from specific targeted groups. The employee groups are those that have had significant barriers to employment.

The work opportunity credit has been extended to cover certain individuals who began working for a company in 2020, specifically qualified long-term employment recipients.

The tax credit is based on three factors:

  • The category of workers hired
  • The wages paid to those workers in their first year of work, and
  • The hours they work

The program is in place for individuals who began work or will begin work after December 31, 2014, and before January 1, 2021.

What Types of Workers Qualify for WOTC?

Let's say your business is hiring. The first thing you need to do is determine if a worker you are hiring fits into one of the specific categories that qualify you for the work opportunity tax credit. The categories of workers you can hire to qualify for the work opportunity tax credit are:

  • Veterans
  • TANF Recipients (Long-Term Temporary Assistance for Needy Families)
  • SNAP (Food Stamp) Recipients
  • Designated Community Residents (living in Empowerment Zones or Rural Renewal Counties).
  • Vocational Rehabilitation Referral
  • Ex-felons
  • Supplemental Security Income (SSI) Recipients
  • Summer Youth Employee (living in Empowerment Zones)
  • Long-Term Familly Assistance Recipients
  • Qualified Long-Term Unemployment Recipients

In addition to the general qualification, there are specific qualifications within each category. This Dept. of Labor Work Opportunity Tax Credit Eligibility Chart includes details.

How to Qualify the Worker

During the hiring process, on or before the employee begins work, there are two forms you and the applicant must complete. If you don't complete the forms during the hiring process, you won't be able to get the tax credit.

First, you and the applicant must complete IRS Form 8850, the IRS pre-screening form.

  • When the job offer is made, the applicant completes the first page showing their eligibility.
  • When the applicant is hired, you as the employer complete the second page giving your information and information on the hire.

Don't file form 8850 with the IRS. Instead, file with your state workforce agency of your state no later than the 28th calendar day after the person begins working for you. Here's a list of state workforce agencies.

Second, you and the applicant must complete Department of Labor Form 9061. The applicant completes the form and you as the employer verify the documents the person submits as verification. (Some applicants may have already completed Conditional Certification DOL Form 9062 instead.)

As soon as the worker is hired, you must submit these two forms to your state workforce agency (or state employment agency) for a determination on the eligibility of this worker for WOTC credit. You will receive a determination letter from this agency giving you the worker's eligibility status.

Which Employees Are Not Eligible?

Even if they might otherwise make your business eligible for the tax credit, you can't get the tax credit for hiring

  • Your relatives or dependents, including children, stepchildren, spouse, parents, siblings, step-siblings, nephews, nieces, uncles, aunts, cousins, or in-laws
  • Majority owners of your business

Wages Counted for the Tax Credit

Now that you have hired employees who make your business eligible for the tax credit, the next step is determining the amount of wages for the tax credit for each eligible employee. The wages must be paid in the first year of employment, so you will have to wait until you have one year's pay to make the application for the tax credit to the IRS.

You can include all payments made to the employee in that year, with these details:

  • The wages must be wages on which your business has paid Federal Unemployment (FUTA) tax, and
  • They must actually have been paid by your business directly. Wages subsidized by another party or indirectly paid through your business don't count toward the WOTC.

Hours Worked and the Maximum Work Opportunity Tax Credit

Next, it gets a little more complicated when figuring the hours worked and the amount of the tax credit. The amounts differ depending on the category of the employee.

The employee must have worked 120 hours or more during the year. Then, your business can earn 25% of the wages if the employee works at least 120 hours and 40% if the employee works at least 400 hours. There are maximum hours for each category.

Filing for the Work Opportunity Tax Credit

After the worker is hired, and you have received the letter from your state's workforce agency showing that the worker qualifies, you can claim the tax credit by completing and submitting IRS Form 5884 with your business tax return. For this form, you will add up all the wages of qualified workers, depending on their hours worked and their category, and multiply these amounts by the number of hours worked during the year and the appropriate percentages (as described above).

The IRS says you can apply for the credit against your business income tax liability for the year and normal carry-forward rules apply.

Tax credits are complicated and the tax laws change frequently. Get help from your tax professional before you apply for the credit.