Understanding the work opportunity tax credit: An introduction for small business owners

The Work Opportunity Tax Credit (WOTC) is a federal tax credit that rewards employers for hiring minorities. The credit can be a significant incentive for small businesses, helping to reduce their tax liability while also improving the quality of their workforce. However, navigating the complexities of the WOTC program can be challenging, especially for small business owners who may not have the resources to dedicate to tax planning and compliance.

This article aims to provide an introduction to the Work Opportunity Tax Credit for small business owners, explaining the eligibility requirements, calculation of the credit, required paperwork, deadlines, common pitfalls to avoid, and best practices for claiming the credit. By understanding the fundamentals of the WOTC program and following best practices, small business owners can maximize the benefits of the credit while avoiding costly mistakes and legal liabilities.

Whether you are a small business owner looking to hire new employees or a tax professional seeking to help your clients take advantage of the WOTC program, this article will provide valuable insights into the requirements and best practices for claiming the credit. So let’s dive in and explore the world of the Work Opportunity Tax Credit.

Eligibility requirements

The Work Opportunity Tax Credit (WOTC) is designed to encourage employers to hire employees from targeted groups that face significant barriers to employment. To be eligible for the credit, employers must hire employees from one or more of the following targeted groups:

1. Temporary Assistance for Needy Families (TANF) Recipients: Individuals who have received TANF benefits for any nine months during the past 18 months.
2. Veterans: Veterans who have been unemployed for at least four weeks within the year prior to being hired, or veterans who have a service-connected disability and were unemployed for at least six months within the year prior to being hired.
3. Ex-Felons: Individuals who have been convicted of a felony and were released from prison within the past year, or who have been unemployed for at least six months.
4. Designated Community Residents: Individuals who live in an Empowerment Zone, Enterprise Community, or Renewal Community.
5. Vocational Rehabilitation Referrals: Individuals who have a physical or mental disability that results in a substantial impediment to employment and who have been referred to the employer by a state vocational rehabilitation agency.
6. Summer Youth Employees: Individuals (16–17 years old) who live in an Enterprise Community, Empowerment Zone, or Renewal Community, or who have been suggested to the employer by a local summer youth programme.
7. Supplemental Nutrition Assistance Program (SNAP) Recipients: Individuals who are between the ages of 18 and 39 and who are members of a household that received SNAP benefits for at least six months during the previous year.
8. Long-Term Unemployed: Individuals who have been unemployed for at least 27 consecutive weeks and who have received unemployment compensation during some or all of that time.

It is important to note that not all employees from these targeted groups will be eligible for the WOTC. In addition to meeting the eligibility requirements for their respective groups, employees must also meet certain other criteria, such as being a new hire and working a minimum number of hours. To determine eligibility and ensure compliance with the program, employers should consult with a tax professional or refer to the Department of Labor’s WOTC Guide for Employers.

Calculation of the credit

Once an employer determines that they have eligible employees, they can claim the Work Opportunity Tax Credit (WOTC) by completing and submitting IRS Form 8850 to their state workforce agency within 28 days of the eligible employee’s start date.

The amount of the credit varies depending on the employee’s target group, the wages paid to the employee, and the number of hours worked by the employee during their first year of employment. The maximum credit amount ranges from $1,200 to $9,600 per eligible employee.

A veteran who has been jobless for at least six months and who has a service-connected disability may be eligible for a credit equal to 40% of the first $24,000 of wages paid to the employee during the first year of employment, up to a maximum credit of $9,600.

It’s important to note that the credit can only be claimed for wages paid during the employee’s first year of employment, and the employer must have a reasonable expectation that the employee will work at least 120 hours during that year.

To claim the credit, employers must also complete IRS Form 5884 and include the credit amount on their income tax return. The credit can offset the employer’s income tax liability dollar-for-dollar, and any unused credit can be carried back one year or forward up to 20 years.

It’s important for employers to keep accurate records of the eligible employees they hire and the wages paid to them, as well as any other required documentation to support their WOTC claim.

Required paperwork

To claim the Work Opportunity Tax Credit (WOTC), employers must complete and submit two forms: IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, and IRS Form 9061, or 9062, depending on the employee’s target group.

Form 8850 is used to request certification from the state workforce agency that the employer’s new hire is a member of a specific target group that is eligible for the credit. The form must be completed by the employer no later than the day the job offer is made to the employee.

Form 9061 or 9062 is used to gather additional information about the employee’s eligibility for the credit, depending on their target group. For example, if the employee is a member of the Long-Term Unemployment Recipient target group, they must complete Form 9062.

Both forms must be signed by the employer and the eligible employee, and submitted to the state workforce agency within 28 days of the eligible employee’s start date. The state workforce agency will review the forms and issue a certification to the employer if the employee meets the eligibility requirements for the credit.

Employers should also keep detailed records of the eligible employees they hire, including their names, Social Security numbers, and start dates, as well as copies of the completed IRS forms and any other required documentation to support their WOTC claim. These records should be retained for at least three years after the due date of the tax return on which the credit was claimed.

Deadlines

Employers must submit Forms 8850 and 9061 or 9062 to the state workforce agency no later than 28 days after the eligible employee’s start date. The state workforce agency will review the forms and issue a certification to the employer if the employee meets the eligibility requirements for the credit.

The deadline to claim the credit on an employer’s federal income tax return depends on the employer’s tax status. For example, a sole proprietor must claim the credit on their personal income tax return, which is due by April 15th of each year (or the following Monday if April 15th falls on a weekend).

Employers who are partnerships or corporations must file their tax returns by the 15th day of the third month after the end of their tax year. For example, if a corporation’s tax year ends on December 31st, their tax return is due by March 15th of the following year.

It is important for employers to keep track of these deadlines to ensure that they claim the credit on time and maximize their tax savings.

Common pitfalls to avoid

When claiming the Work Opportunity Tax Credit (WOTC), employers should be aware of common pitfalls to avoid to ensure that their claim is successful. Some of the most common pitfalls include:

1. Failing to meet the eligibility requirements: Employers must ensure that their new hires meet the eligibility requirements for the WOTC before submitting their certification request to the state workforce agency. If the new hire is not a member of an eligible target group, the employer will not be able to claim the credit.
2. Missing the deadline: Employers must submit their certification request to the state workforce agency within 28 days of the eligible employee’s start date. Failing to meet this deadline will result in the employer being ineligible to claim the credit.
3. Incomplete or inaccurate paperwork: Employers must complete Forms 8850 and 9061 or 9062 accurately and completely, with all required information included. Any errors or omissions could result in the employer being ineligible for the credit.
4. Not keeping adequate records: Employers must keep detailed records of their eligible employees and the certification process, including copies of Forms 8850 and 9061 or 9062. Failure to keep adequate records could result in the employer being unable to prove their eligibility for the credit.
5. Incorrectly claiming the credit: Employers must ensure that they claim the correct amount of the credit and that it is claimed on the correct tax return. Incorrectly claiming the credit could result in the employer being subject to penalties and interest.

By avoiding these common pitfalls and following best practices for claiming the WOTC, employers can maximize their tax savings and ensure compliance with federal tax laws.

Best practices for claiming the credit

To ensure a successful claim for the Work Opportunity Tax Credit (WOTC), employers should follow best practices throughout the process. Some of the best practices include:

1. Understand the eligibility requirements: Employers should familiarize themselves with the eligibility requirements for the WOTC to ensure that their new hires meet the necessary criteria for the credit.
2. Screen all new hires: Employers should screen all new hires to determine if they are members of an eligible target group. This can be done using Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit.
3. Submit certification requests promptly: Employers should submit their certification requests to the state workforce agency within 28 days of the eligible employee’s start date to avoid missing the deadline.
4. Keep accurate records: Employers should keep detailed records of their eligible employees and the certification process, including copies of Forms 8850 and 9061 or 9062. This can help to ensure compliance with federal tax laws and avoid any issues with claiming the credit.
5. Monitor the hiring process: Employers should monitor their hiring process to identify any potential eligible employees and ensure that they are properly screened and certified.
6. Consult with a tax professional: Employers should consider consulting with a tax professional to ensure that they are claiming the credit correctly and maximizing their tax savings.

By following these best practices, employers can increase their chances of successfully claiming the WOTC and maximize their tax savings.

Conclusion

The Work Opportunity Tax Credit (WOTC) is a valuable tax credit that can provide significant savings for eligible employers. To claim the credit, employers must follow a specific process and meet certain eligibility requirements. By understanding the eligibility requirements, completing the required paperwork, meeting deadlines, avoiding common pitfalls, and following best practices, employers can successfully claim the WOTC and maximize their tax savings. It’s important for small business owners to be aware of the WOTC and take advantage of this valuable tax credit to reduce their tax liability and improve their bottom line.

15/03/2023