Introduction
The Employee Retention Credit (ERC) has been a vital financial relief tool for businesses navigating economic challenges, especially during the COVID-19 pandemic. However, one common question among business owners is: Are salaries of S corporation (S Corp) shareholders included in ERC calculation? The answer is not as straightforward as one might think, and understanding the nuances can prevent costly mistakes when claiming the ERC.
This article delves into the specifics of ERC eligibility for S Corp shareholders, providing clarity on whether their wages qualify, IRS guidelines, and potential tax implications.
Understanding the Employee Retention Credit (ERC)
The ERC is a refundable tax credit designed to encourage businesses to keep employees on payroll during difficult times. This credit was introduced under the CARES Act in 2020 and has undergone several modifications under subsequent legislation, including the Consolidated Appropriations Act and the American Rescue Plan Act.
Key Features of ERC:
- Eligibility: Businesses that experienced a significant decline in gross receipts or were subject to government-mandated shutdowns.
- Credit Amount: Varies by year, with up to 50% of qualified wages (2020) and up to 70% (2021) eligible for credit.
- Applicable Wages: Includes wages paid to employees, but special rules apply to business owners and family members.
Are S Corp Shareholder Salaries Considered for ERC?
IRS Guidelines on S Corp Shareholder Wages
The IRS has clear rules regarding whether S Corp shareholder wages qualify for ERC. The main determining factor is whether the shareholder owns more than 50% of the company. According to IRS guidance:
- Wages paid to an S Corp shareholder who owns more than 50% of the business do not qualify for ERC.
- Wages paid to an S Corp shareholder owning 50% or less may qualify, but additional considerations apply.
Attribution Rules and Family Members
A major reason S Corp shareholders with over 50% ownership are excluded is due to attribution rules under Section 267 of the tax code. These rules state that ownership is attributed to family members, including:
- Spouse
- Parents
- Children
- Grandchildren
This means that if a shareholder’s combined ownership (direct and attributed) exceeds 50%, their wages are not eligible for ERC.
Examples of How S Corp Shareholder Wages Are Treated
Example 1: Single Shareholder with 100% Ownership
John owns 100% of his S Corp and pays himself a salary. Because he owns more than 50%, his wages are not eligible for ERC.
Example 2: Two Equal Shareholders (50/50 Ownership)
Sarah and Mike each own 50% of their S Corp. In this case, their wages may be eligible for ERC since neither owns more than 50%. However, if they are related (e.g., siblings or spouses), attribution rules could disqualify their wages.
Example 3: A 60% Shareholder with Family Attribution
Lisa owns 60% of an S Corp, while her husband owns 10%. Even though her direct ownership is 60%, her husband’s ownership is attributed to her, making her total ownership 70%. As a result, her wages are not eligible for ERC.
What About Wages Paid to Non-Shareholder Employees?
While S Corp shareholders’ wages may be excluded based on ownership percentage and attribution rules, wages paid to non-shareholder employees remain eligible for ERC. This means that an S Corp can still benefit from ERC if it has qualifying employees on payroll.
How to Ensure Compliance When Claiming ERC
To avoid errors or potential IRS audits, S Corp owners should follow these steps:
- Review Ownership Structure: Identify all shareholders and determine if they exceed the 50% threshold when applying attribution rules.
- Document Payroll Records: Keep detailed payroll records to support any ERC claims.
- Consult a Tax Professional: Given the complexity of ERC rules, consulting a CPA or tax expert ensures compliance and maximizes available credits.
Conclusion
While the ERC provides valuable financial relief, S Corp shareholders who own more than 50% of the business (including family attribution) are generally not eligible to count their wages toward the credit. However, S Corps can still claim ERC for wages paid to non-shareholder employees.
If you’re an S Corp owner looking to navigate ERC eligibility, consult a tax expert to ensure compliance and maximize your benefits.
Andre Cuevas provides career insights, job search strategies, and professional advice to help individuals navigate the job market and achieve their career goals.
