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Related-Party Restriction Prompts Concern About Retention Credits

Posted on Aug. 12, 2021

Practitioners were generally pleased to have new IRS guidance clarify unclear aspects of the employee retention credit, but some were surprised by a related-party rule governing qualified wages for majority owners.

Nathan Smith of CBIZ Inc. said Notice 2021-49, 2021-34 IRB 1, released August 4 to provide additional guidance on the ERC for the remainder of 2021, produced an “amusing rule” that links tax treatment of majority owner wages to the existence of specific relatives.

The notice says that “a majority owner of a corporation is a related individual for purposes of the employee retention credit, whose wages are not qualified wages, if the majority owner has a brother or sister (whether by whole or half-blood), ancestor, or lineal descendant.”

Smith told Tax Notes that the rule essentially denies the qualified wage benefit under the ERC simply because, for example, the majority owner has a brother or sister, even if that brother or sister has nothing to do with the business.

“So a 100 percent shareholder-employee can have his or her own wages qualify, but a 51 percent shareholder-employee will never have his or her own wages qualify if that person happens to have a daughter, sister, etc.,” Smith said.

Kristin Esposito, director for tax policy and advocacy at the American Institute of CPAs, noted that some practitioners were surprised to see the related-party distinction — a long-standing constructive ownership concept — included in the context of majority owner qualified wages for the ERC.

However, Esposito said the guidance is clear-cut. “If you have any of those existing relatives and you're the majority owner of a corporation or the spouse, and you are working there, then your wages don't qualify [for the credit],” she explained.

Smith emphasized that the IRS's conclusion on the issue doesn’t turn on whether wages are actually paid to one of the majority shareholder’s relatives. 

“A majority shareholder’s sibling, for example, could have nothing at all to do with the employer, and yet the majority shareholder’s wages will still be disqualified under the IRS guidance,” Smith said.

Esposito agreed, remarking that those relatives could be living on a yacht somewhere and have nothing to do with the business.

“Those people just have to exist,” Esposito said. “But you can have situations where [wages] do qualify because you just don't have those particular relatives.”

Much-Needed Clarification

Esposito said the AICPA was “really pleased” overall with the notice, adding, "It did provide answers to some of the unanswered questions we had.”

Besides addressing majority owner wage treatment, Notice 2021-49 provides guidance on full-time employees, treatment of tips as qualified wages, and the timing of the qualified wages deduction.

“The question whether tips qualify for the credit was one that our membership asked a lot,” Esposito said. The notice clarifies that cash tips over $20 in a calendar month qualify.

The AICPA also fielded questions about counting employees to determine whether an employer is a small employer (having 500 or fewer full-time employees) or a large employer (having more than 500 full-time employees).

The full-time equivalent became more known to employers because of rules under the Affordable Care Act, so “there was confusion about whether you count the full-time employees or full-time equivalent employees,” Esposito explained.

The guidance clarifies that full-time employees, rather than full-time equivalent employees, should be counted for purposes of the ERC.

Administrative Adjustments

For the qualified wages deduction, Notice 2021-49 confirms that the time when the ERC is earned is the time when the qualified wages are paid. A section 280C adjustment must be made in the federal income tax return that corresponds to that time frame. 

“This may mean that an amended federal income tax return or administrative adjustment request will be required when the income tax return is originally filed without the 280C adjustment,” Smith said.

Smith pointed to a 2019 IRS directive regarding the section 280C adjustment required for work opportunity credits, which he says indicates that the IRS won’t challenge the timing of the section 280C adjustment when it is made in a later year than is technically required.

However, Smith added, “The IRS apparently decided that it did not want to extend this ‘grace’ to the 280C adjustments required for ERTC purposes.”

Esposito pointed out that there were questions about how Paycheck Protection Program loan borrowers could go back and claim the ERC because of changes in the Consolidated Appropriations Act, 2021 (P.L. 116-260), allowing the use of both forms of relief.

“Employers and CPAs were asking . . . ‘Do we have to file amended returns, or can we just back it out of the next year’s federal income tax return?’” Esposito said.

Esposito said Notice 2021-49 clarified that “yes, you have to include that reduction in the wage deduction in the year the qualified wages were paid or incurred, even if the taxpayer has to file an amended return.”

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