Raise Hell: Save Your Employee Retention CreditTax Planning
In what clearly must be a mistake, the IRS issued Notice 2021-49 to deny the employee retention credit (ERC) on the wages paid to most C and S corporation owners.
According to the IRS:
- Your corporation can qualify for the ERC on the wages paid to a more than 50 percent owner of an S or C corporation if that owner does not have any living brothers and sisters (whether whole- or half-blood), spouse, ancestors, or lineal descendants.
- Your corporation cannot qualify for the ERC on the more than 50 percent owner’s wages if one of those relatives (other than the spouse) is alive.
Example 1. Tom owns 100 percent of his S corporation, and he has no living relatives. Under this new IRS notice, Tom’s corporation can qualify for up to $33,000 in ERC on Tom’s wages.
Example 2. John owns 100 percent of his S corporation, but he has one living relative, a two-year-old daughter. John’s corporation does not qualify for the ERC. Under the new IRS notice, the two-year-old daughter owns by attribution 100 percent of the S corporation, and the IRS says that John, now a tainted relative, works for her and does not qualify for the ERC.
Whoa, that’s not logical!
Also, it may be technically incorrect.
And it’s possible that lawmakers will kill this IRS rule.
Example 3. Jack and Jill are married and own a corporation 50-50. They are both employees of the corporation, and they have no living siblings, ancestors, or lineal descendants. Under the new IRS notice, both Jack and Jill can qualify for the ERC.
- Using the IRC Section 267(c) attribution rules, the IRS says that Jack’s ownership is attributed to Jill and Jill’s ownership is attributed to Jack. Thus, Jill owns 100 percent. Jack owns 100 percent.
- Under IRC Section 51(i)(1)(A), the spouse is not a relative for ERC disallowance purposes.
- Thus, the corporation, by attribution, owned 100 percent by Jill pays Jack wages that can qualify for the ERC.
- And this same corporation that’s also, by attribution, owned 100 percent by Jack pays wages to Jill that can qualify for the ERC.
You have to read this and say, “This is just not logical to me.” You’re not alone; it’s not logical to us, either. And it’s not logical to many other seasoned tax professionals.
We’ll get into the technical aspects of this later, but for now just know that you can possibly make this bad news for you as a corporate owner go away.
How to Fix It
You can’t sit on your hands and say, “Shucks.” You need to take action now by telling your lawmakers to enable the ERC for C and S corporation owners.
You may think you are not a player here, but you are. Remember when, 13 months ago, we also asked you to raise hell, to ensure the deductibility of expenses paid with Paycheck Protection Program (PPP) money?
- Original PPP trouble. The IRS said, to the dismay of many lawmakers, business owners, and tax professionals, that the expenses paid with PPP money were not deductible.
- The PPP fix. Business owners and tax professionals communicated their desires for deductibility to lawmakers, and presto! On December 27, 2020, lawmakers enacted a new law that corrected the IRS and made expenses paid with PPP money tax-deductible.
Lesson learned. You are a force to be reckoned with.
It’s time for another reckoning. To ensure the ERC for majority owners of C and S corporations, call, fax, or send an email or letter to the tax law writers, your senators, and your congressional representative:
- Richard Neal, Chairman, Committee on Ways and Means, United States House of Representatives (telephone: 1-202-225-5601; fax: 1-202-225-8112)
- Kevin Brady, Ranking Member, Committee on Ways and Means, United States House of Representatives (telephone: 1-202-225-4901; fax: 1-202-225-5524)
- Ron Wyden, Chairman, Committee on Finance, United States Senate (telephone: 1-202-224-5244; fax: 1-202-228-2717)
- Mike Crapo, Ranking Member, Committee on Finance, United States Senate (telephone: 1-202-224-6142; fax: 1-202-228-1375)
- Your two senators (telephone: 1-202-224-3121; for email and other contact info, click here)
- Your congressional representative (telephone: 1-202-224-3121; for other contact info, click here)
Please note that when you reach out in this way, it often feels as though you are communicating with a black hole and your message is not getting any attention. That’s wrong. Senators and congressional representatives log everything. You are being heard.
Even if you leave a voice mail and receive no reply, know that your voice is being heard.
To Amend or Not to Amend
Let’s start with this premise. You are a more than 50 percent owner of a corporation. You thought that your corporation qualified for the ERC. At various times before August 4, 2021, the day when the IRS issued Notice 2021-49, you filed your claim to the ERC for 2020 and the first two quarters of 2021.
As we mentioned, when you filed, you believed (as a more than 50 percent owner of a C or S corporation) that wages paid to you by the corporation qualified for the ERC. We did too, as we said in Can You Claim the ERC for the Owner of a C or S Corporation?
But then, on August 4, 2021, the IRS issued Notice 2021-49 and said no—you don’t qualify. What now? Here’s what we think you should do:
- Wait. Do nothing now. There’s no hurry. You have until April 15, 2024, before you have to do anything about your 2020 ERC.
- Wait. Don’t claim the ERC for the more than 50 percent corporate owner for calendar year 2021 quarters 3 and 4 until you have clarification that you qualify. Again, there’s no hurry. You can file a Form 941-X anytime within the three-year statute of limitations.
Why Waiting Is Good
The number one thing to know here is that there’s no rush. Also, it’s possible that lawmakers will step in and fix this injustice, even without prodding. Here are a few reasons why this is possible:
- Lawmakers will debate the ERC during September when they return from recess. It’s already on the table for discussion in the infrastructure bill, and that discussion increases the possibility of something good happening before the end of the year.
- The IRS issued Q&A 59 on November 6, 2020.8 That notice clarified which relatives don’t qualify. The owners were not in the disqualified group. We discussed this in Can You Claim the ERC for the Owner of a C or S Corporation? Lawmakers have to consider this IRS Q&A in their discussions.
- Lawmakers will consider that corporate owners had reason to believe they qualified for the ERC on wages paid between March 13, 2020 and August 4, 2021,9 when the IRS issued its newest and contradictory version.
- Congressman Jack Bergman, 1st District, Michigan, wrote the IRS commissioner explaining his reasons why the IRS notice is illogical and needs to be rewritten.
You are going to see one of the following outcomes:
- Lawmakers will decide that the IRS is wrong and then change the rules (perhaps beneficially, or perhaps not).
- Lawmakers will decide that the IRS is correct but unfair, and thus make the IRS rule effective, but only after August 4, 2021.
- Lawmakers will do nothing.
Besides the possibility of the fix taking place, here are three things to consider:
- In Badaracco, the U.S. Supreme Court stated, “The Internal Revenue Code does not explicitly provide either for a taxpayer’s filing, or for the Commissioner’s acceptance, of an amended return; instead, an amended return is a creature of administrative origin and grace.” In other words, you are not under an obligation to file an amended return when you discover that you made an error.
- The IRS in its regulation states, “If a taxpayer ascertains that an item should have been included in gross income in a prior taxable year, he should, if within the period of limitation, file an amended return and pay any additional tax due.”11 (Note the word “should,” not “must” or “shall.”)
- For the tax pro, Circular 230 states that if you know a client owes additional tax, you must inform the client of that fact and of the consequences of not fixing the error.12 Note that the notification to the client creates no obligation for the client to file an amended return.
What If You’re Right?
Of course, if you were correct when you filed for your ERC as a more than 50 percent owner, there is no penalty. And we believe you were correct when you filed before Notice 2021-49 muddied the waters.
If the IRS prevails and you have to return the ERC money, would you suffer penalties? We think not. You have reasonable cause for filing as you did, and reasonable cause can avoid any penalties.
In the unlikely event that your reasonable cause argument fails, your penalty probably would be the 10 percent penalty for failure to deposit taxes.
The constructive ownership rules of IRC Section 267(c) identify related parties but do not determine whether there’s a transaction between them.
From what we have seen, you don’t trigger Section 267 without a sale or exchange of property. There’s no such event with the ERC. Therefore, we believe that IRS Notice 2021-49 does not properly apply Section 267 to the ERC.
By reviewing the twisted logic in Notice 2021-49, you can see that something is wrong there.
Public Law 95-30 created IRC Section 51 in 1977 (yes, 44 years ago). Reviewing the legislative history of Section 51 from 1977 through today, we fail to find an enactment dialog that states the more than 50 percent owner of a corporation is not entitled to the credits under Section 51, which the ERC is to mimic.
Beginning in 2007, we found “present law” statements in committee reports that stated: “No credit is allowed for wages paid to an individual who is a more than fifty-percent owner of the entity.”16 From what we can see, there’s no evidence of this statement appearing in the reasons for enactment or description of changes made in prior legislation. To us, it appears as if the staff lawyer who described the prior law made this conclusion on his or her own without finding such wording associated with enactment legislation.
In other words, the subsequent “present law” description of a law does not make for legislative history.
One further note on this point: The IRS did not use this “the more than 50 percent owner does not qualify” description to disallow the ERC for corporate owners. If this were original legislative history, it would have been a simple statement for the IRS to make rather than use the convoluted and illogical language found in Notice 2021-49.
If you are a more than 50 percent corporate owner, you need to communicate with the tax law writers, your senators, and your congressional representative to save your ERC.
IRC Notice 2021-49 is too illogical to survive. Don’t sit on your hands—take action.
See the congressional contact information in the article for whom to call and where to send your correspondence.
Here is what you can do today:
- Communicate with your congressional representatives.
- If you have the ERC in your pocket, wait. Don’t amend your payroll tax returns now.
- If you have not yet filed for the ERC for the more than 50 percent corporate owner, wait. You have plenty of time to file IRS Form 941-X and collect your ERC if and when lawmakers change the guidance.