Tax and financial advice from the Silicon Valley expert.

IRS employee retention credit guidance confounds tax professionals

A recent IRS Notice giving guidance for the employee retention credit has tax professionals scratching their heads.

The IRS issued Notice 2021-49 on August 4, 2021.

According to the Notice, whether wages of controlling owners of a business and their spouses qualify for the employee retention credit depends on whether they have certain relatives.

The Employee Retention Credit is a big deal. If a business otherwise qualifies to claim the credit, the maximum credit for 2020 was $5,000 per employee for the year, and for 2021 is $7,000 per employee per quarter! The credit is refundable. It’s first applied to certain federal payroll taxes and any excess can be refunded or carried forward as a credit on the next federal payroll tax return. The credit is a form of relief for businesses suffering from the COVID-19 pandemic.

(Note that the Biden Infrastructure Plan just passed by the U.S. Senate and sent to the U.S. House of Representatives would repeal the Employee Retention Credit for the last quarter of 2021.)

When Congress adopted the Employee Retention Credit (in a hurry) as part of the CARES Act, it used a shortcut for defining limitations to the wages qualifying for the credit. It adopted related-party rules that already were in place for the Work Opportunity Credit.

Those rules prohibit claiming the credit for wages paid to persons related to a majority owner of a corporation or a majority owner of an unincorporated business. Here is a list of the related persons.

  • A child or descendant of a child
  • A brother, sister, stepbrother, or stepsister
  • A father or mother, or an ancestor of either
  • A stepfather or stepmother
  • A niece or nephew
  • An aunt or uncle
  • A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

In addition, other related party rules are also incorporated that consider an individual to own interests owned by the individual’s family, directly or indirectly, including the individual’s spouse.

According to the IRS Notice, the wages of a majority owner (directly or indirectly) will only be disqualified from claiming the Employee Retention Credit if the majority owner has one of the relatives on the bullet list above.

In Example 3 of the Notice, Corporation C is owned 100% by Individual J. The Corporation otherwise qualifies for the Employee Retention Credit. Individual J is married to individual K. They have no other family members on the list, and they are both employees of Corporation C. Individual K is considered owning Individual J’s stock, so they both are considered 100% owners. Since they don’t have other disqualified relatives, their wages qualify for the Employee Retention Credit.

If either J or K did have a disqualified relative, even if the relative didn’t work in the business or own any stock directly, the wages of the person with a disqualified relative wages would not qualify for the Employee Retention Credit.

Bear in mind, the federal payroll reports for which these credits would be claimed should already have been filed, so this guidance has been issued very late in the game.

In addition, the tax deduction for wages on the business’s income tax return is reduced by the Employee Retention Credit.

This means thousands of payroll tax reports and income tax returns might have to be amended, creating a huge bottleneck for the IRS when it is already behind in processing paper-filed tax returns.

As you can see, this is a very complex issue and I haven’t included all of the details here. If you own a business that has claimed the Employee Retention Credit, I recommend that you have your tax advisor review your situation to determine your exposure and whether filing amended returns is appropriate.

Tax and financial advice from the Silicon Valley expert.