Key Takeaways:
- The employee retention credit is a fully refundable credit to help employers retain employees
- Employers must meet suspension or gross receipt loss requirements to qualify for the credit
- Most majority owners cannot claim their wages for the ERC, though there are special cases
- Individuals who are closely related to the business owner usually don’t have qualifying wages
- Majority owners without siblings, parents, or children may be able to claim the ERC for their wages
The employee retention credit (ERC) was created during the pandemic to give businesses some relief from payroll taxes, encouraging them to avoid employee layoffs. Businesses that saw a decline in their gross receipts or were shut down because of governmental orders qualify for the credit.
There has been some confusion about whether the wages business owners earn from their business qualify for the ERC and the wages of people related to them, such as children or parents who work for their company.
This guide will walk through the basics of the ERC, eligibility requirements, whether owners’ wages qualify, and wage exclusions for related individuals.
A Brief Overview of the ERC
The ERC was first introduced in 2020 as part of the Coronavirus Aid, Recovery, and Economic Security Act (CARES Act). It was put in place to help support employers through challenging times of business closures and losses.
The covered periods were first from March 13, 2020, to December 31, 2020, and were then extended to the end of 2021 as part of the American Rescue Plan Act of 2021. Only business recovery startups were eligible for the ERC through December 31, 2021; other businesses have an end date of September 30, 2021. Business recovery startups are businesses that started operating after February 15, 2020, and have less than $1 million in gross receipts.
Legislation in 2021 increased the number of qualified wages per employee that a business can claim. Employers can earn up to $5,000 per employee in 2020, and up to $21,000 per employee in 2021 (or $28,000 for business recovery startups). The ERC for 2020 is half of the qualified wages with a limit of $10,000 for all quarters, and 70% of qualified wages in 2021, with a limit of $10,000 per quarter instead of per year.
Here’s how the credit works: It first offsets payroll taxes for employers, and then it’s fully refundable. The IRS gives eligible businesses cash payments for this credit, so it’s different from an income tax credit. Businesses need to figure out their credit amount and complete Form 941-X, Amended Quarterly Payroll Tax Return, and send it to the IRS.
Businesses eligible for the ERC that didn’t claim the credit on their tax return can still take advantage of it today. The IRS says they can file the Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund form to claim it for 2020 and 2021, but only for qualifying quarters.
Eligibility Requirements for the ERC
Not all businesses qualify to take this credit, even if they have employees and experienced changes during the pandemic. There are two ways that businesses are eligible for the ERC:
1. Suspended Operations
Eligible businesses must have suspended their operations, either fully or partially, in 2020 or 2021 to qualify for the ERC. These suspensions must have been caused by a government order regarding business restrictions during the pandemic.
2. Decline in Gross Receipts
The other way to qualify is through losses. A business must have seen a significant decline in its gross receipts during an eligible period. An eligible period is when their gross receipts declined 50% for a 2020 quarter when compared to the same quarter in 2019, and 20% less in 2021 when compared to the same quarter in 2019.
You don’t qualify for the ERC if you had no employees in 2020 or 2021. Businesses that received a Paycheck Protection Program (PPP) loan weren’t initially eligible for the ERC, but further legislation, known as the Consolidated Appropriations Act of 2021, extended the credit to PPP recipients.
Large employers should also make sure they qualify. The first legislation set out for the ERC dictated that large employers were those with over 100 employees. The updated law in 2021 changed that definition to those with more than 500 employees. This is significant because large employers can only claim wages paid to employees kept by the employer but didn’t work. Learn more about these ERC eligibility requirements by contacting a tax expert.
Majority Owners’ Wages and the ERC
The ERC requirements may seem straightforward, but they can become trickier when business owners are figuring out whether their own wages qualify. Owners are technically earning wages for their work at the company, but they don’t necessarily count in the IRS’s guidelines for the employee retention credit.
There has therefore been a lot of confusion about whether the wages earned by majority owners qualify for the ERC. These wages are the earnings that owners receive from the company. In August 2021, the IRS released Notice 2021-49, which offered some clarity to businesses on this issue. In most cases, majority owners’ wages are not qualified for the ERC.
However, there are some additional terms to know. The same notice outlined that owners’ wages aren’t eligible if that owner has a brother, sister, half-brother, half-sister, ancestor, spouse, or other lineal descendants.
The wages paid to a major owner and their spouse qualify for the ERC if they don’t have any of these living relatives, however. Shareholders owning less than 2% of the business and who are also employees may qualify as well.
Explaining Constructive Ownership
It’s also important to understand something called constructive ownership. Constructive ownership is taken on by a person closely related to the business’s actual owner whom the IRS then treats as an owner. For example, if a person owns all of a corporation’s stock, their spouse would be a constructive owner of that stock.
Constructive ownership is different from direct ownership, when the owner owns the business, and indirect ownership, when someone owns an company that owns another company.
4 Qualified Wages Exclusions for the ERC
Most business owners likely can’t include their wages for the ERC. Do family members’ wages qualify for employee retention credit? Here are the types of related parties whose wages are excluded from the ERC:
1. Individuals
Any person who is related to the owner in the following manner wouldn’t have wages that qualify for the ERC:
a. Child or child’s descendent
b. Sibling (brother, sister, stepbrother, stepsister)
c. Father, mother, or their ancestors
d. Stepparent
e. Niece or nephew
f. Aunt or uncle
g. In-laws: son, daughter, father, mother, sister, brother
h. Individuals who aren’t a spouse who reside in the same principal household
2. Corporations
Individuals mentioned above related to someone who owns over 50% of outstanding stock.
3. Entities That Are Not Corporations
Individuals mentioned above related to someone who owns over 50% of capital and profits interests.
4. Trusts or Estates
Beneficiaries, fiduciaries, grantors, or any related individual listed above who is a beneficiary, fiduciary, or grantor.
Any wages earned by self-employed individuals are also not considered qualified wages. These requirements and exclusions aren’t always easy to understand on your own. Make sure you contact the ERC experts now to learn more.
Examples of Eligibility for the ERC for Related Individuals
The ERC can be pretty complicated when it comes to owners and determining whether their wages qualify. They need to pay close attention to all the moving parts of their family relationships. They could have more than half ownership of the business due to the IRS’s constructive ownership rules through people related to them or through trusts.
The IRS provides a few helpful examples in its Notice 2021-49 regarding the ERC, ownership, and employee retention credit for family members. Let’s break these scenarios down to better understand these complex rules:
Example 1
Individuals E and F own Corporation A. E owns 80% and F owns 20%. Corporation A is eligible for the ERC from 2021’s first quarter. E and F are both employees of Corporation A, and both are treated as 100% owners of Corporation A. They are related to one another in a way listed under the relational exclusions. Neither E’s wages nor F’s wages are considered qualified because they are related individuals.
Example 2
Individual G owns 100% of Corporation B. Individual H is G’s child. Corporation B employs G but not H. Both G and H are treated as 100% owners of the company since they are related individuals. Thus, G’s wages do not qualify.
Example 3
Individual J owns 100% of Corporation C. J is married to K, but they have no other family members as applicable to the ERC exclusions. They are both employees of Corporation C. Both individuals are treated as 100% owners of the company. However, because they have no other applicable family members, the wages they earn from Corporation C may qualify if they meet all other requirements.
Example 4
Individual L owns 34% of Corporation D, Individual M owns 33%, and Individual N owns 33%. L, M, and N are siblings. All three of them are employees of Corporation D, and they are all treated as 100% owners of the company because of the law. Their wages therefore do not qualify for the ERC because of their relationship with one another.
Example 3, where the owners’ wages are eligible for the ERC, is a rare situation. The others exemplify how majority ownership, direct familial attribution, and constructive ownership rules work. Whatever situation you’re dealing with, make sure to discuss your options with an ERC expert.
Common Pitfalls of ERC-Related Individuals
Mistakes do happen, especially when it comes to taxes. The ERC sounds straightforward, but many business owners still make errors when filing a claim. Here are some common pitfalls to avoid when figuring out what to do about owners, ERC-related individuals, and claiming the ERC:
- Including unqualifying owners’ wages: One of the biggest mistakes business owners make is including the wages of an unqualifying majority owner in a filed credit claim. This mistake can usually be resolved by submitting a tax return amendment.
- Not including qualifying owners’ wages: A majority owner who has no living parents, no siblings, and no children may be able to include their qualified wages in the ERC claim.
- Rolling over wages to the next quarter: Some employers may want to roll over wages if an employee exceeded $10,000 in one quarter. The amount over $10,000 cannot be rolled over to the next quarter.
- Claiming the credit without meeting business requirements: The business had to have shut down because of a governmental order or seen the applicable declines in gross receipts to qualify for the ERC.
Carefully consider the ERC guidelines surrounding family members before claiming the credit. Having all the information about the ERC, eligibility requirements, and qualifying wage requirements will help you make sure you’re doing everything correctly.
Contact ERC Today with Questions
The ERC provides a significant financial benefit to most employers, which is a saving grace during and after the pandemic. Business owners may mistakenly think their own wages qualify for the credit, though in most cases they don’t. Understanding the exclusions based on ERC family members and ownership status will help you determine whether you can include your wages in your calculations.
Another way to be sure you’re doing everything the right way is to work with the team at ERC Today. We’ll answer any questions or concerns you have about this credit, including whether you’re eligible and how to submit your claim.
ERC Today delivers industry-leading speed and accuracy in our services, tax consulting, filing options, and dedicated support representatives to meet your needs.
Contact ERC Today for more information about your employee retention credit options.
