IRS Issues New ERC (Employee Retention Credit) Guidance: Clarifies Owner/Spouse Restrictions

Date: August 09, 2021

On August 4, 2021, the IRS released Notice 2021-49 (Notice), which provides additional guidance on the employee retention credit (ERC). Here is an overview of the most relevant portions of the guidance for small business owners.


Majority Owner and Spouse Wages

The IRS gave long-awaited clarification on when wages paid to majority owners (more than 50%) and their spouses qualify for the ERC. Unfortunately, the guidance provides that majority owners and their spouses will not qualify for the credit in almost all situations. If the majority owner has any living family other than their spouse (by blood or marriage), their wages likely cannot be qualified.

These rules are outlined on pages 25-31 and give the following explanation: Under Section 152(d)(2)(A-H) of the Internal Revenue Code, wages paid to employees with any of the following relationship to a more than 50% owner are not “qualified wages”:

  1. Child or descendant of a child.
  2. Brother, sister, stepbrother, or stepsister.
  3. Father or mother, or ancestor of either.
  4. Stepfather or stepmother.
  5. Niece or nephew
  6. Aunt or uncle.
  7. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in law, or sister-in-law.
  8. An individual, other than a spouse, who for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.

Constructive ownership rules apply to the ERTC. Section 267(c) of the Internal Revenue Code discusses constructive ownership of stock or a corporation and section (4) states this rule:

  • (4) the family of an individual includes only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants

A direct majority owner’s ownership is attributed to each family member with a relationship described in 267(c)(4).

Combining these rules…

  1. A more than 50% owner’s wages are not qualified wages if they have a brother or sister (whole or half-blood), ancestor, or lineal descendant. That is because ownership is attributed to these individuals and the owner would still bear a relationship excluded by 152(d)(2)(A-H) to the constructive owner.
  2. A more than 50% owner’s spouse’s wages are not qualified wages if the owner has a brother or sister (whole or half-blood), ancestor, or lineal descendant, then the spouse’s wages would also not be qualified wages for the same reason
  3. A more than 50% owner’s wages and spouse’s wages are qualified wages if the owner has neither a brother or sister (whole or half-blood), ancestor, or lineal descendant.

Examples:

  1. E is the child of F. E owns 80% of Company A and F owns 20%. Company A qualifies for the ERTC in 2021 Q1. Under 267(c)’s constructive ownership attribution rules, each is considered to own 100%. E is a related individual under 152(d)(2)(C) and F is under 152(d)(2)(A), meaning neither’s wages can be treated as qualified wages for the ERTC.
  2. G owns 100% of Company B. H is G’s child, but is not an employee of Company B. Company B qualifies for the ERTC in 2021 Q1. Under 267(c), both G and H are treated as 100% owners of Company B. G is a related individual under 152(d)(2)(C) and their wages are not qualified wages.
  3. J owns 100% of Company C. Company C qualifies for the ERTC in 2021 Q1. J is married to K, but they have no family members described in Section 267(c)(4) of the Code. Under 267(c), both J and K are treated as 100% owners. Because J and K lack a relationship to each other described in 152(d)(2)(A-H), both of their wages are qualified wages for the ERTC.
  4. L owns 34% of Company D, M owns 33%, and N owns 33%. L, M, and N are siblings. Company D qualifies for the ERTC in 2021 Q1. Under the attribution rules of 267(c), each are treated as 100% owners. After this attribution, they each bear a relationship to each other (majority owners) described in 152(d)(2)(B). Thus none of their wages are qualified wages for the ERTC.

Recovery Startup Businesses

For 2021 Q3 & Q4, a “recovery startup business” is eligible to claim the ERTC. A recovery startup business is one that:

  1. began carrying on any trade or business after February 15, 2020, *** A business begins “carrying on any trade or business” when it begins to function and performs the activities for which it was organized.
  2. the average annual gross receipts of the employer for the three-taxable-year period ending in the taxable year preceding the calendar quarter for which the credit is claimed, does not exceed $1,000,000, and
  3. is not otherwise eligible for the ERTC based on a full or partial suspension of business operations or a decline in gross receipts.

For a “recovery startup business”, the maximum allowed for each of 2021 Q3 and 2021 Q4 is $50,000.

Like the ERTC generally, one determines whether they are a “recovery startup business” for each calendar quarter. A business may qualify in 2021 Q3, but not in 2021 Q4 because it is eligible for the ERTC based on a decline in gross receipts or suspension of operations.


Counting of Full Time Employees

  • To determine if an employer is a large eligible employer or small eligible employer (over 100 employees in 2020 and over 500 in 2021) a business need not include “full-time equivalents.”
  • When identifying qualified wages, “full-time” status of an employee is irrelevant.

Severely Distressed Financial Employer (SDFE)

For 2021 Q3 & Q4, an SDFE is one whose gross receipts are at least 90% less than the same 2019 quarter. Stated differently, the gross receipts cannot exceed 10% of the same 2019 quarter. A business can use the alternative quarter election (comparing immediately preceding quarter to the same 2019 quarter) to qualify.

Examples:

    1. Business A’s gross receipts in 2021 Q3 are only 7% of the 2019 Q3 gross receipts. This business qualifies as an SDFE.
    2. Business B’s gross receipts in 2021 Q3 are 27% of the 2019 Q3 gross receipts. However, 2021 Q2’s gross receipts were 9% of 2019 Q2’s gross receipts. Business B qualifies as an SDFE in 2021 Q3 based on the alternative quarter election.

If a business qualifies as an SDFE, then it may count any wages paid to qualifying employees during the eligible calendar quarter as “qualified wages.” The limitation on large employers only claiming wages paid when an employee is not providing services does not apply.

If you filed an amended payroll tax returns for 2020 to claim the credit for wages now deemed to not qualify, you will likely be required to file an amended payroll tax return and repay that credit back to the IRS. NFIB encourages you to check with a tax professional to ensure compliance with all IRS rules and guidance.

NFIB and the NFIB Small Business Legal Center do not provide tax, legal, or accounting advice. This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors.

Updated August 9, 2021

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