The Dos and Don’ts of Wage-Based Incentives

The IRS offers a handful of wage-based tax credits to small and mid-sized businesses, but many of those credits go unclaimed. Business owners are often hesitant to apply for new incentive programs because they aren’t sure if they’re eligible or if they’ll be able to handle the reporting requirements. But wage-based incentives can be quite powerful. Adding just one wage-based incentive to your arsenal can make the cost of employment that much more manageable.

What Are Wage-Based Incentives?

Wage-based incentive programs reward employers with deductions and credits that are calculated using wages paid or incurred. Here are some of the most common wage-based incentives from the past couple years:

Research and Development Tax Credit

The R&D tax credit is calculated as a percentage of the company’s R&D expenses. Qualifying expenses include more than just wages, but for many businesses wondering how to claim R&D credits, wages can make up the bulk of the expenses on which the credit is calculated.

Work Opportunity Tax Credit

The WOTC rewards employers who hire workers from certain marginalized groups, including ex-felons, food stamp recipients, and veterans. The credit is calculated as a percentage of qualifying employees’ first-year wages. Employer typically can only take the credit one year per qualifying employee.

FICA Tip Credit

The FICA tip credit is awarded to owners of service businesses — typically restaurants — whose workers make at least some of their income from tips. The FICA tip credit has the potential to refund employers the 7.65% FICA taxes they paid on tip income.

Empowerment Zone Employment Credit

The empowerment zone employment credit is calculated as 20% of wages paid to employees that worked in a qualified empowerment zone, which are economically depressed census tracts located across the US.

Paycheck Protection Program (NOW EXPIRED)

The paycheck protection program (PPP) provided low-cost loans to businesses in 2020 and 2021 based on average monthly payroll costs. Even though businesses can no longer apply for the program, they may still be able to get their loans forgiven. Loan forgiveness is only approved if employers used their funds to pay for qualifying expenses and if a certain percentage of those costs were from wages.

Emergency Paid Leave Credits (NOW EXPIRED)

The paid sick and family leave credits introduced by the Families First Coronavirus Response Act (FFCRA) were awarded to employers that offered their employees paid leave. The credit was based on each employee’s pay. While the credit is now expired, employers may still be able to claim the credit on amended returns.

Employee Retention Credit (NOW EXPIRED)

The employee retention credit (ERC) is also expired, but in 2020 and 2021, it was awarded to employers who retained their workforce through the worst parts of the pandemic. For businesses wondering how to claim the ERC, it was calculated (for most) as a percentage of wages paid between March 13, 2020 and September 30, 2021, up to certain limitations. While the credit is now expired, employers may still be able to claim the credit on amended returns.

The Dos and Don’ts of Wage-Based Incentives

If you do decide to try out a wage-based incentive, there are a few “dos and don’ts” to think about.

Don’t Use the Same Wages for More Than One Incentive

Most of the time, wages can’t be used twice to qualify for more than one incentive in a single year. For example, businesses were allowed to claim both the ERC and earn eligibility for PPP loan forgiveness in the same year, but they could not use the same wages for both calculations. Tax planning software like Corvee can help you allocate wages to ensure you get the highest tax savings possible. 

Do Know What Counts as Wages

Knowing how to count wages may be more difficult than you think. Do health plan expenses count? Do tips your employees received count as wages paid by the business? What about bonuses and other discretionary payments? Each incentive is different, so you’ll have to read the fine print to know for sure how to calculate wages.

Don’t Double Dip Deductions and Credits (Unless It’s Allowed)

You may have to forego a deduction to take a wage-based credit. For example, if you claim the WOTC, you must reduce your payroll deduction by the credit amount. Similarly, if you claimed the ERC, the IRS doesn’t allow you to take a deduction for the wages you used to qualify for the credit.

Do Know When You Need to Amend

To claim a wage-based credit, you may need to amend your payroll or income tax returns.

Consider the ERC: the ERC was originally only offered for pay periods in 2020, but in 2021, it was retroactively extended. If you had already filed payroll tax returns in 2021, you may have had to amend those returns to claim the ERC.

Similarly, you may need to amend an income tax return to claim a wage-based credit. For example, if you applied for the 2020 ERC in 2021, you may have already filed your 2020 income tax return. If you had, you likely would have been required to amend your 2020 income tax return to reduce your wage deduction. Amending a Federal income tax return will likely require you to amend all your state returns, as well, so before you claim a wage-based credit, know what you’re getting into.

Don’t Forget About Financial Reporting

Taxes are only one piece of the puzzle. Do you know how to record the wage-based credits on your financial statements?

The most common question is whether wage-based credits should be credited to payroll expense or if they should be listed as a separate line item and presented elsewhere. Another common question is when those incentives should be recorded. If a credit was awarded in a different year than when you incurred the expenses, in what report year does the credit belong?

The answer — which you may have already guessed by now — is “it depends.” How you record your incentive will depend on the type of incentive and your internal reporting policies. Income tax credits (like the WOTC) will likely follow a different set of accounting guidance than grants (like PPP loan forgiveness).

Wage-Based Incentives — Are They Worth It?

It’s not surprising that some businesses steer clear of wage-based incentives. Some of these programs have hefty compliance and reporting requirements, and some business owners think the administrative hassles outweigh the benefits. Fortunately, if you work with a tax advisor and accountant you trust, incentives programs like the ones we mentioned above don’t have to be overwhelming. Ask your tax professional if they use Corvee today.