To Claim or Not to Claim: That Is the Question
The COVID-19 employee retention credit is a valuable tax benefit for qualifying businesses; however, there is much debate if the wages of a more than 50% shareholder of a qualifying business are eligible.
For the one employee/owner S corporation, this credit has a maximum value of $5,000 during tax year 2020 and $28,000 during tax year 2021, depending on overall salary amount and quarters of eligibility. Since the business cannot deduct wages equal to the credit amount, the lost deduction will reduce the net value of the tax credit.
Per the CARES Act, the Consolidated Appropriations Act, 2021, and new §3134, “rules similar to” §51(i) apply to the COVID-19 employee retention credit.
§51(i)(1) has awkward wording. Here is the language as it would apply to a corporation owner:
No wages shall be taken into account… with respect to an individual who bears any of the relationships described in subparagraphs (A) through (G) of §152(d)(2)… to an individual who owns, directly or indirectly, more than 50 percent in value of the outstanding stock of the corporation… (determined with the application of section 267(c)).
The relationships in §152(d)(2)(A) through (G) are:
A child or a descendant of a child,
A brother, sister, stepbrother, or stepsister,
The father or mother, or an ancestor of either,
A stepfather or stepmother,
A son or daughter of a brother or sister of the taxpayer,
A brother or sister of the father or mother of the taxpayer, and
A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
From a plain reading of §51(i)(1), the wages of an employee who has one of the above relationships to a more than 50% shareholder are ineligible for the COVID-19 employee retention credit.
The issue for the shareholder lies within “(determined with the application of section 267(c)),” which are rules for the constructive ownership of stock. Certain family members — brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants — are constructive owners of the stock.
The issue is best demonstrated with an example: John is the 100% shareholder of ABC Corporation. John’s sister’s Rhonda constructively owns 100% of the ABC Corporation stock under §267(c)(2). John is the brother of a 100% shareholder; therefore, his wages are ineligible for the credit.
This constructive ownership analysis would generally disqualify any more than 50% shareholder who has living family members. A more than 50% shareholder with no parents, no siblings, and no children would likely qualify as there is no family member with constructive ownership of the stock.
This seems like an odd way to prohibit the more than 50% shareholder when a direct statement of disallowance would be clearer — but as we all know, Congress sometimes writes odd statutes. There is no IRS or Congressional authority directly interpreting §51(i)(1) in such a manner.
The Joint Committee on Taxation Explanation of the PATH Act, JCX-144-15, does state on page 59 that “No credit is allowed for wages paid to an individual who is a more than fifty-percent owner of the entity” with respect to the §51 work opportunity credit but provides no explanation or reasoning for that statement.
When Congress added §51(i) to the Internal Revenue Code in 1981, the Committee Report for the 1981 Economic Recovery Tax Act simply described the provision as follows:
Hiring of relatives.
The credit is denied for hiring relatives of the employer.
In addition, IRS Frequently Asked Question 59, which is the IRS’s informal guidance on the application of §51(i) to the COVID-19 employee retention credit, simply states that certain relatives of more than 50% shareholders are disqualified but never states the shareholders themselves are ineligible for the credit.
I see one easy path for the wages of a more than 50% shareholder to qualify for the COVID-19 employee retention credit. The statute says that rules similar to §51(i) apply to the credit. This gives the IRS leeway on a strict porting of all §51(i) rules to the COVID-19 employee retention credit; however, the IRS would need to issue clear authority using this reasoning.
We now go to the key question: can a taxpayer claim the COVID-19 employee retention credit for more than 50% shareholder wages with the above uncertainty?
In a prior edition of this newsletter, I discussed uncertain tax positions. You can meet your Circular 230 obligations and avoid §6662 accuracy-related penalties if there is a reasonable basis for the position along with adequate disclosure.
Here are the three options as I see them currently:
If you do not believe there is a reasonable basis for the position, then you cannot sign an original or amended tax return taking that position.
If you believe there is a reasonable basis for the position, then you can sign an original or amended tax return taking that position; however, you should consider disclosing the position on the tax return.
Wait for future IRS guidance. You can always amend the Form 941 to claim a refund within the refund statute of limitations, which is generally three years from the filing date of the tax return or two years from the payment date, whichever is later. You would also have to amend the business return for the tax year in which the taxpayer earned the credit to reduce the wage expense deduction.
If you believe there is a reasonable basis for the position, then I would discuss the options and potential net tax savings with the taxpayer and let the taxpayer decide on how to handle the issue.
If you claim the credit for the wages of the more than 50% shareholder, and it later becomes clear that the more than 50% shareholder wages are ineligible, then you can submit a qualified amended return, as long as the assessment statute of limitations remains open, to correct the issue with no §6662 accuracy-related penalty.
We will discuss qualified amended returns in the next edition of this newsletter.
Articles I Recommend
Procedurally Taxing discusses the ethical issues to consider when a practitioner realizes that the IRS made an error in Tax Court litigation in Accepting Gifts from the IRS: Ethical Considerations (Part One) and Accepting Gifts from the IRS: Ethical Considerations (Part Two).
Upcoming Education Events
Compass Tax Educators - May 6, 2021 - Virtual
Fringe Benefits and Accountable Plans (2 CE
Oregon Society of Tax Consultants - May 21, 2021 - Newport, OR
American Rescue Plan Act of 2021 (3 CE)
Advanced Rental Property Tax Issues (2 CE)
Tax Planning Strategies for Business Owners (2 CE)
Virginia Society of Enrolled Agents Spring Seminar - June 2-4, 2021 - Virtual
Introduction to IRS Representation (2 CE)
California Society of Enrolled Agents Super Seminar, June 9-10, 2021 - Virtual
Tax Planning for C Corporations (2 CE)
Tax Court: From Start to Finish (2 CE
Arizona Society of Enrolled Agents Southwest Fest- June 14-16, 2021 - Avondale, AZ
Advanced Rental Property Tax Issues (4 CE)
COVID-19 Hot Topics for 2020 Tax Returns (2 CE)
Penalty Abatement Strategies (2 CE)
National Association of Enrolled Agents (NAEA) National Tax Practice Institute- June/July 2021 - Virtual
Level 1: Statutes of Limitations (2 CE); Ethics (2 CE)
Level 2: Penalty Abatement Strategies (2 CE); Capstone Course (co-teaching with Clarice Landreth) (2 CE)
Spidell Summer Tax Webinar Series - July 2021 - Virtual
Update on IRC §199A (2 CE)