Note to readers: the issue outlined below only applies to 50%-or-greater shareholders — which means the business is a corporation — and their spouses who work at the company. It does not apply to sole proprietors or partners — those two groups do not get paid via payroll and therefore are not eligible. Shareholders who own less than 50% are eligible if the business meets the other requirements to claim the credit.
If you are a 50%-or-greater shareholder and your company qualifies for the Employee Retention Credit for either 2020 or 2021, please read on.
I truly cannot believe that it’s June 2021 and I’m writing a blog post to help people choose the least-worst 2020 Employee Retention Credit interpretation — because even though the pandemic is starting to show in our rearview mirrors, we are still living in a universe totally devoid of IRS guidance on the topic of ERC shareholder eligibility. Accountants jokingly refer to this mystery as the Tax Advisers’ “Area 51” on #TaxTwitter.
What am I talking about? And why am I so annoyed? Let me set the scene:
1) Many small business owners are eligible retroactively for the 2020 Employee Retention Credit (ERC), and the IRS decided that the corresponding reduction in wages for that credit needs to be on the 2020 tax return.
2) However, the company’s Paycheck Protection Program (PPP) Forgiveness application needs to be prepared before calculating the amount of the ERC, in order to maximize the amount of financial relief the client receives between the two programs. Therefore, at our firm, these returns are all on extension while we run these calculations.
3) Now that the first round of PPP loans are nearing the end of the payment deferment period — and to be fair, we’re also only a few months away from the tax return extension deadline — we would like to finalize those calculations and returns. (Reminder: there is no “deadline” for applying for PPP Forgiveness — per the SBA, “borrowers can apply for forgiveness any time up to the maturity date of the loan. If borrowers do not apply for forgiveness within 10 months after the last day of the covered period, then PPP loan payments are no longer deferred, and borrowers will begin making loan payments to their PPP lender.”)
4) The catch is — that the IRS has still not released guidance on whether or not 50%+ owners of a corporation are eligible for the credit (or their spouses who work for the business). Accountants are split down the middle on what the existing legislation, which is extremely unclear, tells us on the topic. As such, we either need to take a position or continue to wait for IRS guidance.
What’s that? You’re saying the IRS has still not issued essential guidance on a credit that was created in the first month of the pandemic? Yes. Yes, I am.
Recently, both the AICPA and Tony Nitti, two of my most trusted sources, have weighed in on this with a big “why is the IRS dragging their heels on this” reaction. Nitti went as far as to say, “Are wages paid to greater than 50% owners eligible for the credit? If I had a nickel for every time someone emailed me this question, I could afford to stop shamelessly and relentlessly shilling this newsletter. It is absolutely amazing that a full year after the ERC was created, we still don’t have a definitive answer.”
Okay, enough backstory. As a small business owner, what are your options? I call them Choice 1 (yes) and Choice 2 (no) for short:
- #1 Calculate ERC as if owners are eligible and file 2020 income tax returns accordingly. This would result in a higher tax for clients (because more wages are disallowed as deductions). Submit PPP Forgiveness applications, but hold off on submitting ERC claims (941-Xs) until guidance is released. If guidance indicates that owners are eligible, file the ERC claims accordingly. If guidance says owners are not eligible, then amend the income tax returns and file the ERC claims accordingly.
This approach may make the most sense when there are two 50%-owners on payroll, and not many other other staff — as the increased credit would be worth the wait, compared to the total credit without owners.
- #2 Calculate ERC as if owners are not eligible and file 2020 income tax returns accordingly. This would result in a lower tax for clients (because fewer wages are disallowed as deductions). Submit PPP Forgiveness applications, and submit ERC claims (941-Xs) — rather than holding off on these as in the above option. If guidance is eventually released that indicates owners are not eligible, then no action is needed. If guidance indicates that owners are eligible, then decide whether it is worth amending the income tax returns and ERC claims to get the additional funds.
This approach may make the most sense with only one 50%+ owner and many employees, as the cost to amend all returns and claims will probably not be worth the additional credit.
The goal with both approaches is to get PPP Forgiveness applications and tax returns filed as soon as possible, with the best balance between wage deductions and potential wage credits.
While I was tempted to pick one of these two approaches and inform all clients of our choice, I decided — especially with advice from an AICPA Town Hall — that this is a decision that each client needs to make for themselves. We’re happy to explain the potential costs and benefits of each approach and make a personal recommendation for each client’s individual situation, but the decision should be theirs. We recommend other CPA firms take a similar approach.
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