How Do Family Members Use the Employee Retention Credit?

During the pandemic, the employee retention credit (ERC) was developed to provide businesses with some relief from payroll taxes. And compel them to keep their workforce intact. Businesses that experienced a drop in revenue or were forced to close due to governmental orders are eligible for the credit. There has been significant uncertainty regarding the eligibility of business owners’ wages for the ERC. As well as the wages of others who are related to them, their family members, such as parents or children who work for the business.

The ERC’s fundamentals, eligibility standards, the eligibility of owners’ wages, and salary exclusions for family members are all covered in this handbook.

Requirements for ERC Eligibility

Even if they employed people and went through changes as a result of the epidemic, not all firms are eligible to claim this credit. Businesses may qualify for the ERC in one of two ways:

1. Operation Stoppages

To be eligible for the ERC, an eligible business must have completely or partially ceased operations in 2020 or 2021. These suspensions must have resulted from a government directive involving pandemic-related business restrictions.

2. Reduction of Gross Receipts

The other means of qualification are defeats. A company’s gross receipts must have significantly decreased during an eligible period. A period is considered suitable if their gross receipts dropped by 50% for a 2020 quarter compared to a comparable quarter in 2019. And by 20% for a 2021 quarter compared to a comparable quarter in 2019.

If you had no employees in 2020 or 2021, you are not eligible for the ERC. Initially, Paycheck Protection Program (PPP) beneficiaries were not qualified for the ERC. However, subsequent legislation, known as the Consolidated Appropriations Act of 2021, expanded the credit’s eligibility to PPP recipients.

Large employers should check their eligibility as well. Large employers were defined as those with more than 100 employees in the initial legislation outlined for the ERC. The criteria were altered by the 2021 law amendment to include companies with more than 500 employees. This is important because large businesses can only recover salaries paid to workers who were retained by the firm. Contact a tax professional to find out more about these ERC eligibility conditions.

The ERC and Majority Owners’ Wages

The ERC standards can appear simple, but they can be challenging for business owners to determine whether their pay qualifies. Although owners are theoretically paid for their labor at the company, they may not be taken into account by the IRS for calculating the employee retention credit.

As a result, it has been difficult to determine whether the majority of owners’ salaries qualify for the ERC. Owners receive these salaries from the business as their earnings. The IRS issued Notice 2021-49 in August 2021, providing businesses with some clarification on this matter. The majority of owner salaries are typically ineligible for the ERC.

There are some more terms to be aware of, though. Owners’ salaries are not eligible, according to the same notification, if the owner has a sibling, half-sibling, brother, spouse, ancestor, or other lineal descendants.

However, if they don’t have any of these living relatives, the earnings paid to the main owner and their spouse are eligible for the ERC. Employee shareholders who own less than 2% of the company may also be eligible.

Examples of Related Persons Who Are Eligible for the ERC

When it comes to owners and assessing whether their wages qualify for the ERC, it can be quite difficult. They must closely monitor all the varying dynamics in their family ties. Due to the IRS’s rules on constructive ownership, they might possess more than half of the company through family members or trusts.

In its Notice 2021-49, the IRS offers several useful illustrations of the ERC, ownership, and employee retention credit for family members. To better comprehend these intricate laws, let’s deconstruct these scenarios:

Example 1

Organization A is owned by people E and F. 80% belong to E, and 20% to F. Starting in the first quarter of 2021, Corporation A is qualified for the ERC. Both E and F are considered to be 100% owners of Corporation A even though both are workers at that company. They have a connection that falls under one of the relational exclusions. Because E and F are connected, neither of their salaries is regarded as qualifying.

Example 2

Individual G owns Corporation B in its entirety. Child of G is the person H. G is employed by Corporation B, but not H. Since G and H are family members, they are both regarded as full owners of the business. G’s salary is therefore ineligible.

Example 3

Person J owns Corporation C entirely. Although J and K are married, neither of them has any additional relatives who fall within the ERC exclusions. Both of them work for Corporation C. Both people are treated as the sole owners of the business. They may still be able to use their wages from Corporation C if they meet all other conditions even though they don’t have any other eligible family members.

Common Mistakes of ERC-Related People

Errors do occur, particularly when it comes to taxes. Although the ERC seems simple, many business owners still submit claims with inaccuracies. Here are some frequent mistakes to stay away from when deciding what to do with owners, those connected to the ERC, and claiming the ERC:

Include owner wages that do not qualify: One of the largest errors that business owners make is to include the wages of a majority owner who is not qualified in a credit claim. Usually, submitting a tax return revision will fix this error.
Not include the wages of eligible owners: The qualified salaries of a majority owner who has no living children, siblings, or parents may be included in the ERC claim.
Wages may be carried over to the following quarter by some businesses if an employee’s total compensation for a quarter exceeds $10,000. Over $10,000 cannot be carried over to the following quarter.
Requesting credit without fulfilling contractual obligations: To be eligible for the ERC, the company must have either experienced the required decreases in gross receipts or been forced to close due to a governmental order.

In Summary

Most employers receive a sizeable financial benefit from the ERC. Which is a blessing both during and after the pandemic. Though they typically do not, business owners may incorrectly believe that their earnings are eligible for the credit.

You can decide if you can include your wages in your computations by being aware of the exclusions based on ERC family members and ownership status.