How does the IRS work opportunity tax credit work?
If you're a business owner, you're likely on the lookout for ways to save money, especially in today's uncertain economic environment. But what if hiring the right person for the job could also earn you a tax break with the Internal Revenue Service (IRS)? That's what the Work Opportunity Tax Credit (WOTC) is designed to do. It rewards companies for hiring people who've had a difficult time finding employment, like veterans, people who have been long-term unemployed and those receiving government assistance.
Established by Congress as part of the Small Business Job Protection Act of 1996, this employer-friendly tax credit creates a win-win scenario: Employers receive tax savings while those who are facing employment barriers gain valuable opportunities to enter or re-enter the workforce and achieve financial independence. And, this federal tax credit can be quite valuable as a business owner, as it can knock thousands off your tax bill for each eligible employee that's brought on board.
But while the Work Opportunity Tax Credit has been around for years, many employers still don't know about it or assume it's too complicated to take advantage of. This credit is worth a closer look, though — especially if you're already hiring.
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How does the IRS Work Opportunity Tax Credit Work?
The Work Opportunity Tax Credit is a federal income tax credit available to employers who hire candidates from certain target groups who have consistently faced significant barriers to employment. The credit, which directly reduces an employer's tax liability on a dollar-for-dollar basis, making it more valuable than a tax deduction, is authorized under the Internal Revenue Code and administered jointly by the IRS and the U.S. Department of Labor (DOL).
The amount of the credit varies based on the number of hours worked and the employee's wages during their first year of employment. For most eligible hires, employers can claim a tax credit equal to 40% of the qualified employee's first-year wages, up to the maximum credit amount for that target group, if the employee works at least 400 hours during their first year. If the employee works between 120 and 399 hours, employers can claim 25% of the first-year wages.
That generally equates to a credit of up to $2,400 per qualifying employee, according to the U.S. Department of Labor. However, the credit amount can go as high as $9,600 for certain veterans and up to $6,000 for individuals who receive long-term government assistance.
To claim the credit, employers must complete these key steps:
- Pre-screen applicants: Before or on the date of the job offer, the employer must have the applicant fill out IRS Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit).
- Submit paperwork: The employer must then submit Form 8850 to the appropriate state workforce agency (SWA) within 28 days of the new employee's start date.
- Receive certification: If the SWA certifies that the employee belongs to one of the WOTC target groups, the employer may claim the credit by filing IRS Form 5884 when submitting their federal tax return.
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What are the benefits of the Work Opportunity Tax Credit?
The most obvious benefit of the WOTC is the reduction in tax liability for business owners. The credit is non-refundable, which means it can directly lower the amount of income tax a business owes for the year, but it won't result in a refund if the credit exceeds the business's tax bill. That said, any unused credit can typically be carried back one year or carried forward for up to 20 years, which makes it even more valuable over time.
Another major benefit is that the credit supports inclusive hiring practices. By incentivizing employers to consider job candidates who might otherwise struggle to find work — such as people with disabilities or those with criminal records — the WOTC encourages diversity in the workforce and helps close employment gaps for marginalized groups.
The program is also available to both for-profit businesses and certain tax-exempt organizations (such as 501(c)(3) nonprofits), although nonprofits can only claim the credit for hiring qualified veterans, SNAP recipients or those who have been unemployed for a certain period of time. For small businesses in particular, though, taking advantage of the WOTC can be a smart way to offset onboarding costs while building a more inclusive team.
Who qualifies for the Work Opportunity Tax Credit?
To qualify for the WOTC, an employee must fall into one of the IRS-defined target groups. Some of the most common groups include:
- Veterans, including those with service-connected disabilities or who have been unemployed for extended periods
- Recipients of Temporary Assistance for Needy Families (TANF)
- Recipients of Supplemental Nutrition Assistance Program (SNAP) benefits
- Designated community residents (those who live in certain economically distressed areas)
- Ex-felons hired within a year of release or conviction
- Vocational rehabilitation referrals
- Summer youth employees living in empowerment zones
- Supplemental Security Income (SSI) recipients
- Long-term unemployed individuals
To be eligible, the employee must be newly hired (and not someone who has previously worked for the business) and must work at least 120 hours for the employer to qualify for a partial credit. Employees who work 400 hours or more generally allow the employer to claim the maximum available credit.
The bottom line
The Work Opportunity Tax Credit represents a valuable but often underutilized resource for businesses seeking to reduce tax liability while expanding their workforce. By providing substantial financial incentives for hiring candidates from disadvantaged backgrounds, the program creates positive outcomes for employers, employees and communities alike.
For businesses interested in claiming the WOTC, the key is understanding the qualification requirements and the certification process. While there is some administrative work involved in claiming this credit, the potential tax savings make it well worth the effort for many employers.
