Payroll-Based Tax Credits
Every year, hundreds of millions of dollars go unclaimed by U.S. businesses.
Many small to medium- sized business are eligible for federal wage-based tax credits for employees hired. But every year, hundreds of millions of dollars go unclaimed by U.S. businesses who are unaware of or overlook these tax programs. The following tax credits are available to businesses that employ workers paid through a W-2. Some of these incentives are address-specific and some are industry-specific.
WORK OPPORTUNITY TAX CREDIT (“WOTC”)
The Work Opportunity Tax Credit (“WOTC”) is a payroll-based tax credit that is available to businesses, as well as non-profit organizations, that have a W-2 payroll and hire new employees.
In the recently proposed Tax Cuts and Job Act tax reform bill (analyzed in more detail in this Guide), the WOTC is listed as one of the programs that may be eliminated after 2017. However, as of this writing, the program is in effect and can provide tax savings opportunities to many businesses seeking to hire more employees.
The credit amount can range from $2,400 to $9,600 per qualified employee, depending upon which targeted group the employee qualifies for. The business may be eligible for the Work Opportunity Tax Credit if a new employee:
- Received conditional certification from a state workforce agency.
- Is currently receiving or has received SNAP benefits.
- Has been long-term unemployed (27 consecutive weeks) and received unemployment compensation.
- Is between the ages of 18 and 40 and resides within a Federal Empowerment Zone.
- Has been an unemployed Veteran for the past six months.
- Was discharged from the U.S. military within the last 12 months.
- Has a service-connected disability.
- Is receiving Supplemental Social Security Benefits (SSI).
- Is receiving or has received Temporary Assistance to Needy Families (TANF).
- Has been convicted of a felony or was released from prison after a felony conviction. The business can utilize a Work Opportunity Tax Credit to offset its corporate tax liability if it is a C corporation. If the business is structured as an S corporation or an LLC, then the credit would flow through to the shareholders or LLC members. For non- profit organizations, the tax credit is applied on the quarterly payroll returns, which will generate a refund.
The process in order to claim the credit can be burdensome for many businesses. In order to initiate a claim, an employee must complete IRS Form 8850 “Pre-Screening Notice and Certification” when initially hired. Furthermore, if a qualifying box is checked on this form, the hiring business must submit the completed pre-screening form, as well as an additional form, to the state’s WOTC Coordinator online within 28 days of date of hire for the application to be considered timely filed. Once an application is approved by the state’s WOTC Coordinator, a certification form will be mailed to the business, which will serve as the required documentation to substantiate the tax credit.
The qualified employee must work at least 125 hours for the business to receive a partial tax credit. If the employee works 400 hours or more, the business will get the full 40% credit, which is usually capped at $2,400 for most target groups.
FEDERAL EMPOWERMENT ZONE TAX CREDIT (“FEZ”)
The Federal Empowerment Zone Tax Credit (“FEZ”) was created by the Clinton Administration in 1996. There are 40 Empowerment Zones located within the U.S., primarily in distressed urban areas. This tax credit expired on January 1, 2017, and is currently in legislative limbo. However, there are amended return opportunities for the 2014-2016 tax years for businesses located within a FEZ.
Some of the country’s largest FEZ’s are located in the following areas:
- Los Angeles
- New Haven
- North Manhattan
- Philadelphia/Camden NJ
- Santa Ana
In order to claim the credit, the business must be located within the Federal Empowerment Zone and the employee must also reside within the zone. The credit amount is equal to 20% of the employee’s first $15,000 of wages and is capped at $3,000 per employee, per tax year. Certain types of businesses such as golf courses, gaming venues, and liquor stores are not eligible for this credit.
A business located within the Federal Empowerment Zone that has five employees who also reside within the zone could be looking at a potential FEZ credit of $45,000 for the 2014-2016 tax years. In order to claim the FEZ credits, the business would have to file amended tax returns for those years.
FICA TIP CREDIT
If you have a business in the food and beverage industry where tipping is customary, the business is entitled to a tax credit that could offset the employer portion of the FICA taxes. In addition to restaurants and bars, county clubs, yacht clubs, business clubs and tennis clubs that have food and beverage operations would also qualify for the FICA tip credit for certain employees. The FICA tip credit is generated from tips received by employees for services on which the business paid the employer portion of the Social Security and Medicare taxes. Only food and beverage operations employees’ wages qualify for the tip credit. The IRS has defined a qualified employee as someone who receives tips for providing, delivering, or serving food or beverage for consumption.
The tip credit is generally the amount of employer Social Security and Medicare taxes paid by the business on tips received by the employee. However, businesses cannot claim the credit for taxes paid on any tips that are used to satisfy the federal minimum wage rate in effect on January 1, 2007, which was $5.15 per hour.
For example, a server worked 30 hours per week and was paid $2.13 per hour. The employee reported $350 in tips for that week. The Federal wage rate is $5.15 an hour for purposes of the FICA tip credit. In this example, the restaurant owner would save approximately $1,000 annually from just this one employee. Now multiply that by 15, 25, 50 or more employees, and the FICA tip credit becomes very substantial.
|Number of Servers||FICA Tip Credit|
Weekly Wages = Hours Worked x Hourly Rate + Reported Tips
30 x $2.13 +$350 =$413.90
Wages Paid at Minimum Wage = Hours Worked X Federal Wage Rate for FICA Tip
30 x $5.15= $154.50
FICA Tip Credit = Weekly Wages – Wages Paid at Minimum Wage x FICA percentage
$413.90 – $154.50 x 7.65% =$19.84
Annual Savings per Employee = Tax Credit x Payroll Frequency
$19.84 x 50 weeks = $992 Tax Credit
Please note that seven states do not allow for a FICA tip credit, since the required cash minimum wage for tipped employees is the same as the state minimum wage. The states are Alaska, California, Minnesota, Montana, Nevada, Oregon and Washington. If the business has not claimed the FICA tip credit, amended returns can be filed for the 2014 – 2016 tax years and as reflected by the above table, the refunds could be significant.
Unfortunately, many businesses are not taking advantage of these wage base credits. Despite the administrative requirements to track eligibility and approval, the benefits can be very substantial and well worth the paperwork.