Small business owners seeking ways to reduce their federal tax liability should consider the Work Opportunity Tax Credit (WOTC): a valuable but often overlooked incentive program designed to reward employers who hire individuals from groups that historically face significant barriers to employment.
This federal tax credit program has been in existence for decades, yet many small business owners remain unaware of its potential benefits. Understanding how WOTC works, who qualifies, and how to properly claim the credit can result in substantial tax savings while simultaneously supporting workforce development initiatives.
What Is the Work Opportunity Tax Credit?
The Work Opportunity Tax Credit is a federal tax credit available to employers who hire and retain individuals from specifically designated target groups. The program serves a dual purpose: it provides meaningful employment opportunities to individuals who face challenges entering the workforce while offering tangible financial incentives to businesses willing to give these candidates a chance.
For most eligible hires, the credit equals 40% of up to $6,000 in qualified first-year wages, resulting in a maximum credit of $2,400 per eligible employee. This calculation applies when the employee works at least 400 hours during the first year of employment.
Employees who work between 120 and 400 hours still qualify their employers for a reduced credit of 25% of qualified wages. This tiered structure ensures that businesses receive some benefit even when employment relationships are shorter in duration.
Employer Eligibility Requirements
Employers of all sizes located in the United States and certain U.S. territories may participate in the WOTC program. Both taxable businesses and certain tax-exempt organizations qualify, though the claiming mechanism differs based on tax status.
Taxable employers claim the Work Opportunity Tax Credit against their federal income tax liability. The credit is reported as a general business credit and can significantly reduce the amount of taxes owed.
Tax-exempt employers face more limited participation options. These organizations may claim the WOTC only against their payroll taxes, and only for wages paid to members of the qualified veteran targeted group. This restriction means tax-exempt employers should focus specifically on veteran hiring initiatives when seeking to benefit from this program.
The 10 Targeted Groups
To qualify for the Work Opportunity Tax Credit, employers must hire individuals from one of 10 designated targeted groups as defined by federal guidelines. Each group represents individuals who face documented barriers to employment:
- Veterans (including disabled veterans and those who have been unemployed)
- Supplemental Nutrition Assistance Program (SNAP) recipients aged 18-39
- Individuals previously incarcerated or convicted of a felony
- Supplemental Security Income (SSI) recipients
- Temporary Assistance for Needy Families (TANF) recipients
- State assistance recipients in specific circumstances
- Long-term unemployment recipients who have been unemployed for 27 weeks or more
- Vocational rehabilitation referrals
- Long-term family assistance recipients
- Designated community residents living in Empowerment Zones or Rural Renewal Counties
The employee must be in their first year of employment with the hiring business to qualify. Rehired employees or those who have previously worked for the same employer do not generate new WOTC eligibility.
Credit Amounts by Category
While the standard maximum credit is $2,400 per eligible employee, certain targeted groups may qualify employers for higher credit amounts:
| Targeted Group | Maximum Credit |
|---|---|
| Standard eligible employees | $2,400 |
| Long-term TANF recipients (Year 1) | $4,000 |
| Long-term TANF recipients (Year 2) | $5,000 |
| Certain disabled veterans | $4,800 |
| Veterans unemployed 6+ months | $5,600 |
| Summer youth employees | $1,200 |
These enhanced credit amounts recognize the additional challenges faced by certain groups and the extra resources employers may invest in their successful integration into the workforce.
The Three-Step Claiming Process
Claiming the Work Opportunity Tax Credit requires careful attention to documentation and strict adherence to filing deadlines. Employers should follow this process for each potentially eligible new hire:
Step 1: Pre-Screening and Certification Request
Before or on the day a job offer is made, employers should complete IRS Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit). This form must be submitted to the appropriate state workforce agency within 28 days of the new employee's start date.
The 28-day deadline is strictly enforced. Late submissions result in automatic disqualification from the credit for that employee, regardless of how clearly the individual meets the targeted group criteria.
Step 2: Receive Certification
The state workforce agency reviews the submitted documentation and issues a certification if the employee meets the requirements for one of the targeted groups. Employers should retain this certification with their tax records.
Step 3: File the Appropriate Tax Form
Once certification is received, employers must file the correct form based on their tax status:
- Taxable employers file Form 5884 (Work Opportunity Credit) and include the credit as part of the general business credit on Form 3800
- Tax-exempt employers file Form 5884-C to claim the credit against payroll taxes
Important Deadlines and Limitations
Several critical limitations apply to the Work Opportunity Tax Credit that employers must understand:
Program Expiration: The current WOTC program authorization extends only to wages paid to employees who begin work on or before December 31, 2025. Congress may extend this deadline, but employers should not assume future availability when making hiring decisions.
Tax Liability Limitation: The credit can reduce an employer's tax liability to zero but cannot generate a refund. If the calculated credit exceeds the taxes owed, the excess cannot be converted to a cash payment.
Carryback and Carryforward Provisions: Unused WOTC amounts may generally be carried back one year and carried forward for up to 20 years. This flexibility helps businesses that experience low-profit years still capture the full value of their credits over time.
Hours Worked Requirements: Employees must work a minimum of 120 hours to generate any credit. Those working 120-399 hours qualify their employer for the 25% credit rate, while those working 400 or more hours qualify for the full 40% rate.
Benefits for Small Business Owners
Small businesses stand to gain significantly from WOTC participation for several reasons:
Direct Tax Savings: Each eligible hire can reduce federal tax liability by up to $2,400 or more, depending on the targeted group. For businesses hiring multiple qualified individuals, these savings accumulate quickly.
Expanded Candidate Pool: By actively considering candidates from targeted groups, businesses access a broader range of potential employees. Many individuals in these groups possess valuable skills and strong work ethic despite facing employment barriers.
No Additional Wages Required: The credit applies to wages the business would pay regardless: there is no requirement to increase compensation above market rates to qualify.
Stackable with Other Credits: WOTC can often be combined with other tax credits and incentives, maximizing overall tax savings.
Documentation Best Practices
Employers seeking to maximize WOTC benefits should implement systematic documentation procedures:
- Screen all new hires during the onboarding process using Form 8850
- Maintain calendar reminders for the 28-day submission deadline
- Track hours worked for all potentially eligible employees
- Retain all certifications and supporting documentation for at least four years
- Coordinate with tax professionals to ensure proper credit calculation and reporting
Next Steps for Interested Employers
Small business owners interested in claiming the Work Opportunity Tax Credit should consult with a qualified tax professional to establish proper procedures. The administrative requirements, while manageable, require consistent attention to detail to capture all available credits.
For assistance with WOTC documentation, tax filing requirements, or other small business tax matters, contact TIG Tax Services to schedule a consultation. Professional guidance ensures that all available credits are properly claimed and documented according to IRS requirements.