The CARES Act encompassed various financial relief programs to aid businesses during the COVID-19 pandemic. Among these programs was the Employee Retention Credit (ERC), which aimed to reward businesses that persevered in paying wages despite facing reduced revenues or operational closures. However, many S corp owners struggle to determine whether their own wages are eligible for the ERC.
Initially, many eligible taxpayers were unsure whether wages paid to owners who were employed by their own businesses would qualify for the payroll tax credit. To address this confusion, the Internal Revenue Service released a notice that provides a definitive answer. Unfortunately, the notice can be quite complex to comprehend.
To simplify matters, here is a more easily understandable explanation of the guidance, which will help you determine whether the wages paid to S corp owners meet the requirements for the Employee Retention Credit.
Eligibility Requirements for Claiming the ERC
The Employee Retention Credit was established by the CARES Act as a tax credit that eligible employers could receive as a full refund. Initially, it applied to the period from March 13, 2020, to December 31, 2020. Initially, there was a maximum limit of $10,000 per employee for all quarters combined, but the annual limit for the ERC was further raised to $28,000 per employee in 2021.
To qualify for the ERC, businesses needed to have employees and meet certain criteria. This included either a partial or full suspension of operations due to a government order, or a significant decline in gross receipts of at least 50% in a quarter compared to the same quarter in 2019.
With the passage of the Infrastructure Investment and Jobs Act, the ERC for 2021 was shortened, ending on September 30, 2021, instead of extending until the end of the year. This change also revised the ERC limit to $21,000 per employee per year, unless the business was classified as a recovery startup business. A recovery startup business refers to a business that commenced operations after February 15, 2020, and has gross receipts of $1 million or less.
Since the legislation did not specify a size limit, both small and large businesses can claim the ERC. Business size does matter, however:
- If the business has 100 or fewer full-time employees for 2020 and 500 or fewer full-time employees for 2021, all employee wages qualify.
- If the businesses has more than 100 full-time employees for 2020 and 500 full-time employees for 2021, only wages paid to workers when they weren’t working because of COVID-19 can be claimed.
The IRS has stated in its ERC FAQs that wages paid to employees who are relatives of their employers are not eligible. For this purpose, relatives are defined as the following:
- A child or a descendant of a child
- A brother, stepbrother, sister, or stepsister
- The father or mother, or an ancestor of either
- A stepmother or stepfather
- An aunt or uncle
- A niece or nephew
- A father-in-law, mother-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law
Wage Qualification Requirements
Wages that are subject to FICA taxes are considered eligible for the ERC. Some health expenses of employees may also qualify. The Employee Retention Credit entails intricate requirements that encompass qualifying quarters, percentage reductions in gross receipts, business shutdown mandates, and eligible wage types. It is crucial to thoroughly review and understand these requirements and guidelines to ensure accurate reporting of the credit amount to the IRS.
Do S Corp Owner Wages Qualify for the ERC?
When claiming the Employee Retention Credit, it is unlikely that you can include S Corp owner wages in your calculations. While the IRS does not explicitly prohibit it, their interpretation of familial attribution and constructive ownership rules generally disqualifies most majority owners from eligibility. The reasoning behind this position may seem convoluted, but it does not allow for much interpretation or leeway.
When the employer is a corporation, a related individual is defined as someone who has a specific relationship with a majority owner (see above). A majority owner, in this context, is an individual who directly or indirectly owns at least 50% of the corporation’s stock.
The confusion regarding wages paid to owners or their spouses arose because the frequently asked questions did not address this specific issue. To provide clarification, the IRS released Notice 2021-49.
Notice 2021-49 establishes that the constructive ownership rules, which determine who qualifies as a majority owner of a corporation, also apply to the ERC. These rules state that an individual is considered to own all the stock owned by their family members, including ancestors, siblings (whole or half), and lineal descendants.
Here’s where it becomes a bit complex: according to the notice, when these rules are applied to the ERC, it implies that wages paid to majority owners who have living siblings, ancestors, or lineal descendants do not qualify for the tax credit.
The reasoning behind the eligibility criteria is this: If you are classified as a majority owner, your siblings, ancestors, and lineal descendants are also considered majority owners. This familial relationship means that as an employee related to a majority owner, your wages are excluded from eligibility for the ERC, as initially stated in the FAQs.
To claim the ERC for your wages as a majority owner, you must not have any living ancestors, siblings, or lineal descendants. Another possibility is being a minority owner with less than 50% ownership in the corporation when considering the family attribution and constructive ownership rules. This analysis takes into account the complexities of familial relationships and the extent of ownership in determining eligibility for the ERC.
Tips for S Corp Owners Claiming the ERC
To claim the Employee Retention Credit successfully, there are several important considerations for S corp owners to keep in mind. Here are some tips to help you navigate the process:
- Claim the ERC retroactively: If you meet the eligibility criteria and haven’t claimed the ERC for 2020 or 2021 yet, you can still do so. You can use Form 941-X, the amended version, to claim the credit for the respective year. You have up to three years from the date of the original tax return filing to claim the ERC.
- Understand how the credit is issued: The ERC differs from typical tax credits. It reduces your Social Security taxes, allowing you to either lower your employment tax deposits or claim the credit amount through filing Form 941-X, which the IRS will process accordingly.
- Claim the ERC even if you received a PPP loan: Initially, the ERC guidelines limited businesses that also received a Paycheck Protection Program (PPP) loan. However, legislation in 2021 changed this restriction, allowing businesses to claim the ERC while having received a PPP loan, as long as they meet other qualification requirements. It’s important to note that you cannot claim the same wages paid using the PPP loan funds.
- Ensure accurate wage reporting: The ERC involves complex requirements, such as qualifying quarters, gross receipts reductions, business shutdown criteria, and eligible wage types. Thoroughly review and understand these requirements to ensure accurate reporting of your credit amount to the IRS. Failure to do so may result in additional delays or complications in receiving your credit.
- File a tax return amendment if needed: Mistakes, such as including wages of a majority owner that do not qualify, can occur. If you discover an error in your tax return, you can rectify it by submitting an amendment. It’s advisable to consult a tax professional if you encounter any mistakes or uncertainties.
- Understand the differences between 2020 and 2021: The ERC becomes more intricate due to legislative changes for 2021. Familiarize yourself with the applicable laws, including the CARES Act, Consolidated Appropriations Act (CAA), American Rescue Plan Act, and other COVID-related legislation. These changes may result in a larger credit for 2021, but note that the program generally ended for most businesses on September 30, 2021.
Claiming the ERC as an S corporation owner doesn’t have to be daunting when you have a good understanding of the relevant laws and are confident that your wages qualify. Consulting an expert in the Employee Retention Credit can provide valuable guidance specific to your situation and help you determine your eligibility.
While S corporation owner wages may generally not qualify for the Employee Retention Credit, it’s essential to note that there are exceptions to this rule. To determine whether you can claim the ERC on your wages or your employees’ wages, it is crucial to conduct thorough research and carefully analyze your specific situation.
The ERC can provide significant financial benefits, potentially amounting to tens of thousands of dollars for your business. Therefore, it is vital to ensure that you do not miss out on this valuable tax break if you meet the eligibility requirements. Take the time to explore and understand the guidelines surrounding the ERC to determine if your business qualifies for this credit.