Are Owner Wages Eligible for the Employee Retention Credit?

The COVID-19 pandemic necessitated widespread business slowdowns and disruptions across all industries. Many owners had to navigate retaining employees amid declining revenues. The Employee Retention Tax Credit provides welcome relief, refunding up to $28,000 per employee in payroll tax credits in 2021. A common question that arises is – can wages paid to owners and partners qualify for this generous tax credit?

The answer depends on the business structure and tax treatment of owner wages. With proper planning, certain business entities can reduce payroll tax liabilities based on owner-employee compensation. This article explores the eligibility rules, calculations, and reporting requirements around claiming owner wages for employee retention credits.

What is the Employee Retention Tax Credit?

First, let’s recap what this valuable COVID relief program entails:

  • Refundable payroll tax credit for eligible employers
  • Enacted by CARES Act in March 2020
  • Expanded and extended by follow-up legislation
  • This applies to qualified wages paid to employees
  • Employers claim credit quarterly on IRS Form 941

The credit amount increased substantially from 2020 to 2021. It is currently set to expire September 30, 2021, barring an additional extension.

How Are Owner Wages Taxed Differently by Entity?

Owner wages are treated differently across business structures, which impacts credit eligibility:

Sole Proprietors and Partnerships

  • Owners pay self-employment tax on all business profits
  • No wages distinct from ownership profits

S Corporations

  • Owners who work in the business receive W-2 wages
  • Wages subject to payroll taxes

C Corporations

  • Shareholders receive dividends, not wages
  • Only common law employee wages qualify for tax credits

Can Owners Claim Wages for the Retention Credit?

With the above in mind, here is the credit eligibility for owner wages:

Sole Proprietors, Partnerships, and S Corps

The IRS permits wages to owners who are also employees to qualify for credits.

C Corporations

Dividends paid to shareholders do not qualify for the credit.

The reasoning aligns with incentivizing employers to retain staff rather than their own compensation.

Rules for Qualified Wages

Assuming the business structure allows it, owner wages must still meet the “qualified wage” definition:

Limited to Common Law Employees

Credits derived from qualified wages paid to common law employees per IRS rules.

Documented COVID-19 Impact Required

Owner-employees must document time unable to work and wages paid for that time due to COVID-19 effects on the business.

Other Qualified Wage Rules Apply

All limitations and exclusions around qualified wages apply (health insurance allocation, exemptions for religious organizations, etc.)

How Can Eligible Owners Claim Credits?

Sole proprietors, partners, and S corporation shareholders claim credits stemming from their eligible wages as follows:

File IRS Form 7202 for Advance Payments

Proactively claim advance payments of expected credit amounts prior to filing quarterly returns.

Claim on Form 1040

Ultimately, the credits attributable to their wages are claimed on their personal Form 1040 tax returns.

Business Return Reporting

S corps and partnerships provide information to owners to report credits on their individual returns.

Key Credit Calculation Considerations

Proper documentation is key to computing credits on owner wages:

Track Time and Wages Related to COVID-19

Carefully track hours not worked and wages paid for COVID-19-related reasons and substantiate with documentation.

Apply a 50% Credit Rate

Take 50% of qualified owner wages paid each quarter, subject to other limits.

Comply with Quarterly Limits

Apply the $10,000 qualified wage limit per employee quarterly when calculating credits.

Conclusion

The employee retention credit provides valuable aid to employers, including eligible owner-employees. To claim owner wages, be sure to understand the rules around business structure eligibility, qualified wage documentation, quarterly credit computations, and proper tax return reporting. Consult a tax professional to ensure full compliance and maximize your available credits.

FAQs

Q: Can LLC members’ wages qualify?

A: Yes, if taxed as a partnership or S corp. For LLCs taxed as C corps, only employees’ wages qualify.

Q: Do dividends paid to owners qualify?

A: No, only W-2 wage payments subject to payroll taxes qualify, not dividends.

Q: Can partners claim W-2 wages from a partnership?

A: No, partners cannot be employees per the IRS and only common law employee wages qualify.

Q: Do wages reduce the partner/S corp owner capital accounts?

A: Yes, eligible owner wages are a reduction to capital accounts, not separately paid to themselves.

Q: How are community property rules applied?

A: Credits attributable to owner wages in community property states are split equally between spouses.

Here are two relevant links related to the article about owner wages and the employee retention tax credit:

IRS Guidance on Shareholders as Employees

The IRS website provides official details on the treatment of S corporation shareholders who are also employees. This covers eligibility for tax credits like the employee retention credit.

Analysis of Tax Credits for Owner-Employees

This article by the Journal of Accountancy examines the nuances of claiming tax credits like the Work Opportunity Credit as an owner-employee. The analysis is relevant to interpreting the employee retention credit rules.

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