Recent changes to state regulations have made the New Employment Credit (NEC) more accessible than ever before. Despite being established in 2014, the NEC has undergone significant reform with the passing of Assembly Bill 2035 in early 2022, opening up new opportunities for businesses across the state.
Thanks to amendments to sections 17053.73 and 23626 of the California Revenue and Taxation Code, businesses can now more easily meet the requirements for the NEC, making it simpler for them to take advantage of the significant tax credits awarded for hiring and retaining employees.
The NEC is an excellent way for qualifying businesses to save money while simultaneously supporting their employees and the state’s economy, providing a financial boost to both developing and established companies.
In this article, we’ll delve into the eligibility requirements for the NEC, including important considerations related to the data that affect the credits’ calculation. We’ll also provide a comprehensive explanation of how the credit works and offer guidance on maximizing its benefits.
By the end of this article, you’ll have a better understanding of how the NEC can help your business thrive.
Benefits Of NEC For California Employers
Lowering costs associated with hiring new employees can be a significant advantage for employers, especially since training and onboarding expenses can add up quickly. The NEC provides a way for employers across California to offset the costs of hiring and improve their businesses cash flow through the tax credit.
An eligible business could receive up to $56,000 in tax credits per full-time employee over a period of five years through the NEC credit. This cash flow can be especially helpful for small businesses that operate on tight budgets. So how do you know if your business is eligible?
Employer Qualification Requirements
The NEC tax credit is a program designed to support California’s developing areas economically by incentivizing businesses to hire eligible full-time employees within a Californian Designated Geographical Area (DGA).
By providing businesses with funds to offset the cost of hiring new employees, the credit creates a win-win situation for the community by promoting job creation and economic growth in areas that need it the most.
However, to qualify for the NEC tax credit, a business needs to meet specific requirements and provide detailed and intricate data. If a business can demonstrate that it has created new jobs within the designated DGA, it can continue to receive the benefits of the NEC tax credit.
First businesses must be licensed and operate within California. Some businesses and services may be excluded if they have aggregate gross receipts of less than 2 million in the previous taxable year.
In the upcoming sections, we will further explain the specific eligibility criteria in more detail. Additionally, the CA.gov Franchise Tax Board website outlines the employee and employer eligibility requirements. If you have any questions or need further clarification, it may be helpful to consult a professional tax agent.
Businesses Must Provide The Right Compensation To Employees
In order to take advantage of the NEC tax credit, businesses must meet specific requirements regarding employee compensation and benefits. This ensures that their eligible employees receive fair compensation, along with access to essential benefits such as basic health insurance and a retirement plan like a 401(k).
These requirements include offering a minimum compensation package that meets these standards. To be eligible for the NEC tax credit, employees must be working full-time or be paid at least 35 hours per week on average. Additionally, an employee is considered a full-time employee for up to 60 months after their initial employment date.
In addition, to qualify for the tax credit, businesses will need to pay their employees an hourly wage that is at least 150% of the state minimum wage at the time they were hired, but no more than 350%. This calculation takes into account actual wages paid, including overtime and commissions.
For salaried employees, their annual salary is divided by the hours on which the salary is based to determine their hourly wage rate. You can find detailed information on the specific wage rates that qualify for the credit on the official CA.gov Franchise Tax Board website.
Business Must Operate Within The Designated Geographical Area (DGA)
To claim the NEC tax credit, businesses first need to meet specific eligibility requirements related to their location and where the employees are working. These requirements are designed to support local communities by providing investment in economic growth in designated geographical areas (DGAs) that are experiencing high levels of unemployment or economic distress.
Under these regulations, a business must operate within a DGA and employ eligible workers who perform at least 50% of their job duties in the designated area. The NEC ensures that businesses invest in their local communities while also providing opportunities for company growth.
It’s important to note that the Department of Finance recently updated census tract eligibility as of January 1, 2020. However, if a business hired eligible employees before this change and those employees are now located outside the DGA, they can still receive the full 60 months of tax credits from their employment date.
You can use this DGA Map tool to determine whether your business is located within the defined DGA, and stay up-to-date with any changes.
Business Must File The Tentative Credit Reservation (TCR)
Businesses must provide a Tentative Credit Reservation (TCR) for each eligible employee before submitting their NEC. On California’s Franchise Tax Board (FTB) website, businesses can find the application link and the specific employee and employer information required to complete the TCR.
Thanks to the recent legislative amendments, the TCR eligibility has been expanded to any full-time employee in their “base year,” which is the taxable year immediately preceding the year in which the employee was first hired.
When submitting a TCR application, businesses must provide specific details about where the employee will be working. While the business address doesn’t need to be within the designated geographical area (DGA), the employee’s work location does.
Additionally, businesses are required to provide yearly data about these employees to the FTB by the deadline for their corporate tax filings.
To ensure a smooth reservation process, it’s recommended businesses review the list of required information carefully before submitting their application. This can be a stressful process and a professional tax agent can assist with this data and documentation.
Completing a TCR is not only necessary for claiming the NEC, but it is also crucial in planning for a business’s future hiring and budgeting plans. Plus, the TCR assures that the funds allocated for the NEC are distributed fairly and efficiently while staying compliant with current legislation.
Importantly, the TCR must be completed within 30 days after fulfilling the Employment Development Department (EDD) hire reporting requirements.
How The NEC Works
As an eligible employer, you’re likely curious about how the NEC tax credit actually works, how it’s calculated, how your business can use it, and any recapture requirements. As we’ve highlighted, the NEC has many criteria and restrictions, and its calculation is influenced by various factors specific to your business and its eligible employees.
For instance, the credit can’t exceed the employer’s net tax costs for the taxable year, and there is a statewide cap for the total credits granted per year. In the following paragraphs, we’ll discuss how the NEC is calculated for your business and offer tips on how to best use the credit, along with potential credit recapture provisions.
How To Calculate The NEC
The NEC tax credit percentage for each calendar year is 35% of the total qualified wages paid. It’s important to note that this credit is only available for employees hired within taxable years starting on or after January 1, 2014, but before January 1, 2026.
To determine the full credit amount that can be reported on your tax return, you need to follow a specific calculation process and consider the various factors that impact it. Let’s take a closer look.
Factors That Affect Credit Calculation
The NEC tax credit calculation has four factors that determine its final value. The first two factors are the number of qualified employees and the total amount of qualified wages paid to them.
Qualified wages are wages paid to eligible employees earning between 150-350% of the California minimum wage within their first 60 months of employment. Once you have calculated the qualified wages, you can determine the tentative tax credit by simply multiplying this amount by 35%.
The applicable percentage is the next factor to calculate, with the total number of full-time employees during the base year and the current taxable year as the second two factors.
To calculate the numerator, which is the net increase of full-time employees, subtract the number of full-time employees in the current taxable year from the number of full-time employees in the base year (tax year before the first qualified employee was hired). If this number is 0 or less, you don’t qualify for the NEC in this taxable year.
Employees are to be calculated to their full-time equivalents for both the base and current tax years. This can be done for hourly rate employees calculated by dividing the total number of hours worked by 2,000 (<2,000) and salaried employees calculated by dividing the number of weeks worked by 52.
Lastly, you need to calculate the denominator, which is the total number of all your employees (NEC-qualified and not qualified) measured in full-time equivalents. To find the final NEC credit allowable, multiply the tentative credit amount by the applicable credit.
The below table outlines an example of how to calculate the final NEC Tax Credit allowable.
| Step | Calculation | Example |
| 1 | Compute Qualified Wages | Company ‘A’ has paid $30,000 qualified wages |
| 2 | Compute the Tentative Credit Amount | Multiply Company ‘A’s qualified wages by 35% = $30,000 x 35% = $10,500 |
| 3 | Compute Applicable Percentage | Example of Company ‘A’ which has:
● Base Year Full-Time Employees = 20 ● Current Year Full-Time Employees = 25 |
| Net Increase in Full-Time Employees = Current Year Full-Time Employees – Base Year Full-Time Employees = 25 – 20 = 5Full-Time Employee Equivalents = (20 x 1) + (5 x 0.5) = 22.5 |
||
| Applicable Percentage = Net Increase in Full-Time Employees / Full-Time Employee Equivalents = 5 / 22.5 = 0.2222 (22.22%) |
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| 4 | Compute Allowable Credit | ● Tentative Credit Amount = $10,500
● Applicable Percentage = 0.2222 ● Allowable Credit = Tentative Credit Amount x Applicable Percentage =
Therefore, the example of Company ‘A’ with qualified wages of $30,000 and a net increase of 5 full-time employees over a base year with 20 full-time employees would be eligible for an NEC tax credit of $2,333.50. |
Credits: Usage, Carryover Of Unused Credit, And Credit Recapture
If you’re a business owner, the NEC Tax Credit could be a valuable financial benefit for your company.
To claim this credit, you’ll need to do so on your original tax return for the year in which you hired eligible employees. And while the credit is non-refundable, meaning you can’t get back more than you owe in taxes, you can carry any unused portion forward for up to five years.
You can use this credit to reduce your state income tax liability or assign it to another eligible business (combined group) that has a positive net income. However, if an eligible employee leaves your company within 36 months of being hired, you may be subject to a credit recapture, requiring you to pay back some of the claimed credit. There are exceptions to this rule, though.
Businesses won’t have to pay back the credit if the employee voluntarily leaves, becomes disabled, is terminated due to misconduct, or is replaced by another qualified full-time employee. And if your business is seasonal and rehires the same eligible employee on a seasonal basis, you won’t have to pay back any previously claimed credits.
Get The Most Out Of The NEC
The California New Employment Credit is a tax credit that benefits both employers and employees by offsetting the costs of hiring and improving cash flow through a tax credit.
Recent changes in California state regulations have made the NEC more accessible to qualifying California businesses, making it an excellent way for businesses to save money while supporting their employees and the state’s economy.
Although a great opportunity for businesses to reduce their tax liability, the specifics of the NEC eligibility requirements and calculation can be complicated. It’s important to note that errors in the calculation or application process can lead to missed opportunities or even penalties. That’s where our team of professionals at J.R. Martin & Associates can be invaluable.
We have the knowledge to help businesses navigate the requirements and complexities of the NEC tax credit, ensuring that they meet all the eligibility criteria and calculate the correct amount of credit. By working with us, businesses can feel confident that they are maximizing the benefits of the NEC tax credit and minimizing their tax liability.
Our firm can help you identify, claim and plan your tax-saving strategies. Learn about our service here.
