Many companies – especially small businesses – were affected when COVID-19 hit the United States. A majority struggled to keep themselves and their employees afloat financially, which is one of the primary reasons the U.S. government stepped in with initiatives such as the Employee Retention Credit.
The Employee Retention Credit (ERC) is a refundable tax credit for companies that continued to pay their workforce while fully or partially shut down because of the COVID-19 pandemic. This tax incentive also applies to businesses that were able to stay open but had a significant decline in gross receipts from March 13, 2020, to September 30, 2021, compared to similar periods in 2019.
In 2020, employers were able to claim refundable ERC credits of up to $5,000 per employee. Subsequent expansions of the ERC raised the potential benefit to $7,000 per employee per quarter in 2021. Businesses that qualify for the ERC can claim the credit based on a percentage of payroll costs, including qualified wages and some health insurance costs.
Do Owner Wages Qualify for the ERC?
In general, wages paid to majority owners with greater than 50 percent direct or indirect ownership of the business do not qualify for the ERC. However, there are situations where a business owner’s wages can qualify for the ERC.
Eligibility Requirements for Owner Wages
Wages paid to a business owner with 50 percent or less ownership interest may be included as qualified for ERC purposes. To determine if an owner has more than 50 percent ownership of a business, you have to also consider indirect ownership through family members. According to the IRS guidelines, family members include:
- A child or descendant of a child (including a stepchild)
- A brother, sister, stepbrother or stepsister
- The father or mother or an ancestor of either
- A stepmother or stepfather
- A nephew or niece
- An uncle or aunt
- A son-in-law, daughter-in-law, mother-in-law, brother-in-law or sister-in-law
A spouse of a corporate stockholder may also be considered a family member in determining if the owner is a majority owner.
Special Considerations for S Corporations
An entity that has elected to be taxed as an S corporation for federal income tax purposes has unique characteristics for ERC calculations. As with other entity types, wages paid to an S corporation’s majority shareholder will generally not qualify for the ERC. However, minority shareholders owning 50 percent or less of the shares may qualify.
To be considered eligible for the ERC, the business must pay the minority shareholder as an employee. In addition to wages for services rendered to the business, an S corporation shareholder may also receive distributions or draws from the business’s profits. Distributions are not subject to payroll taxes and are not reported as wages on the employer’s quarterly payroll reports. Shareholder distributions paid in this manner are not eligible for the ERC. Only the minority shareholder’s wages can be eligible for the ERC.
Other Considerations for Owner Wages
The ERC can be a tremendous tax benefit that can help individual employees, including some business owners. Even though the wages of some business owners may be included in ERC calculations, it is important to carefully review the business’s basic ERC qualifications.
If your business was impacted by the COVID-19 pandemic, and you paid minority owners wages for their services, it may be worth looking into filing a claim for the ERC. There is still time to file a claim, but backlogs at the IRS delay the process, making it important to get your claim filed as soon as possible. The statute of limitations for the ERC in 2020 and 2021 closes on April 15, 2024 and April 15, 2025 respectively.
With the new changes to the ERC guidelines, it is crucial that employers fully understand the proper procedures for an error-free claim process. That is why collaborating with a compliance-first tax technology firm like StenTam is so important.
We have assisted small eligible employers in filing for the Employee Retention Credit and similar employer tax credits. We will work with your business to ensure you receive the full tax credits you are eligible for in each calendar quarter. Contact us today to connect with one of our qualified tax credit associates.