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Hiring employees is an expensive undertaking for any business. But if you hire certain employees, the government wants to make it less expensive for you by offering a Work Opportunity Tax Credit (WOTC) to lower your overall business tax bill.
The Work Opportunity Tax Credit offers a tax credit to employers who hire employees from certain target groups that have historically faced barriers to employment, including ex-felons, veterans and people on long-term unemployment.
This credit is based on qualified wages paid to these employees during their first year of employment. For long-term temporary assistance for needy families (TANF) recipients, the credit is extended to their second year of employment as well.
To claim the Work Opportunity Tax Credit, you will complete Form 5884 and include it with Form 3800 when you file your business taxes.
The Work Opportunity Tax Credit can be a sizeable credit, but varies, depending on these factors:
Depending on an employee is a part of, the Work Opportunity Tax Credit will be subject to different qualified wage maximums. For example, an ex-felon can have $6,000 of allowable wages included in the credit calculation. A long-term TANF recipient can have $10,000 of allowable wages included in the credit calculation.
The credit you can claim will be either 25% or 40% of the qualified wages. If an employee works at least 400 hours during their first year of employment, you can claim 40% of allowable qualified wages. If they work between 120 hours and 400 hours, you can claim 25% of the allowable wages. If they work fewer than 120 hours though, you won’t be able to take the credit.
For example, if you hire an ex-felon for more than 400 hours per year and paid them at least $6,000 in qualified wages, your credit will be $2,400 ($6,000 x 40%). For a long-term TANF recipient who works more than 400 hours per year and is paid at least $10,000 in qualifying wages, the maximum credit is $4,000.
While the Work Opportunity Tax Credit is valuable, there are a number of forms to file and steps to go through before you can get the benefit of the tax credit.
The first step in qualifying for the Work Opportunity Tax Credit is to determine whether an employee falls into one of the target groups. These groups are:
You can find a more detailed description for each of these target groups in the .
If you plan on hiring an employee from a targeted group, the next step is to get a certification from the (SWA) in your state. This certification will be your proof that you’ve hired an employee that qualifies you for the tax credit. You’ll need this certification before you can claim the credit.
There are a few steps you’ll need to take in order to certify that they are a qualified employee:
Once you have both forms completed, you’ll need to submit them to the SWA within 28 calendar days of the start of their employment. It’s important to note that you don’t send these forms to the IRS — certification comes from the SWA.
After you submit these forms, you’ll receive a letter from your SWA approving or denying the employee’s eligibility.
Once you know your employee qualifies, it’s time to calculate just how much of their wages can count toward the tax credit. These are your qualified wages.
Qualified wages are wages on which you’ve paid FUTA tax in the employee’s first year of work (and for long-term TANF recipients, in their second year of work as well). However, these wages don’t include wages you paid while you also received payment from a federal on-the-job training program for the employee. You’ll also need to reduce the wages you paid by any Social Security Act payments you received for the employee.
Once you know the qualified wages, you’ll need to determine the limit for the maximum allowable wages for the employee that you can use in the calculation. Most employees have a maximum allowable qualified wage limit of $6,000, but there are some exceptions. For example, depending on the category of veteran, the maximum allowable wages can go up to $24,000. Summer youth employees have a maximum allowable wage of $3,000.
You can find the various limits for the current year included in the for Form 5884.
To claim the Work Opportunity Tax Credit, most employers will use Form 5884 to calculate their allowable credit. However, if your business is a tax-exempt organization that hired a qualified veteran, you should use Form 5884-C to calculate the tax credit.
You’ll use the maximum wage from Step 3 in the calculation and include it on Form 5884, Line 1 A for employees who worked between 120 and 400 hours in their first year or Line 2 for employees who worked more than 400 hours in their first year.
Once you have the total credit calculated on Form 5884, you’ll include it on , General Business Credit. These forms get submitted with your business tax returns.
The Work Opportunity Tax Credit isn’t refundable, meaning it’s limited by the total tax liability that you have. However, you can carry it forward or backward using the normal rules.
A version of this article was first published on Fundera, a subsidiary of NerdWallet