Since many advisers seem to have difficulty understanding the rules under which certain individuals are barred from having wages qualify for the employee retention credit outlined in IRS Notice 2021-49, I’ve summarized key portions of those rules in the following two sections.  See our main article[1] for the authorities behind each step-by-step process detailed below.

Employee Retention Credit (ERC) Family Attribution Rules

To apply the family stock ownership rules for the employee retention credit, first determine who is deemed under §267(c) to own the shares of each owner.  Anyone on the list below is deemed to own the same shares as the actual owner of the shares:

• Brothers and sisters (whole or half);

• Spouse;

• Ancestors (parents, grandparents, etc.); and

• Descendants (children, grandchildren, etc.).

Total up the number of shares directly owned and deemed owned by §267(c) for each shareholder and each person in the above list.  

From that list, eliminate every person in the list whose shares owned and deemed owned is 50% or less of the total shares actually outstanding (assuming there is only one class of stock--otherwise values will come into play, something not being covered in this simple guide).

For each person remaining on the list who has a “controlling interest” compile a list of each person who has the following relationship to that controlling interest owner:

• A child or descendant of a child;

• A brother, sister, stepbrother, or stepsister;

• The father or mother, or ancestor of either;

• A stepfather or stepmother;

• A niece or nephew;

• An aunt or uncle; and

• A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.

Wages paid to any of these individuals do not qualify for the employee retention credit.  And, in most cases, majority owners and their spouses will end up on this list, meaning their wages will not be able to be used to claim an employee retention credit.

Note:  there other attribution rules you’ll find under IRC §267(c) that need to be considered as well.  Especially troublesome in many cases will be the partnership rules under IRC §267(c)(3).

Employee Retention Credit (ERC) Partnership Attribution Rules

Many small businesses with multiple unrelated shareholders have structured their businesses as follows:

• The operating business (construction company, manufacturing company, etc.) is held in an S corporation and

• Real estate that houses the business is held in a partnership with interests held by shareholders in the S corporation.

This structure can create its own problems for claiming the employee retention credit.  Under §267(c)(3) an individual owning any stock in a corporation is deemed to own the stock owned, directly or indirectly by his partner.  

Example

Mary, Karen and Brian each own ⅓ of MKB Manufacturing.  They also each own ⅓ of MKB Real Estate, LLC (taxed as a partnership) that holds the building that MKB operates in, and leases that building to MKB Manufacturing.  Mary is deemed, under IRC §267(c)(3), to own all of the shares held by Karen and Brian, getting her ownership interest under §267(c) up to 100%.

IRC §267(c)(4)’s bar on double attribution in certain cases applies to shares deemed held by Mary from her partners, so when attributing her shares to her daughter, her daughter is deemed to only own the 33.33% interest directly held by Mary.  So Mary’s wages aren’t put at risk by her daughter’s indirect ownership since it’s only a ⅓ interest.

But any individuals on the relatives list for Mary, Karen and Brian aren’t so lucky, since each of them become deemed 100% owners.  Thus, again wages paid to any of the following relatives of each of them are not eligible for the employee retention credit:

• A child or descendant of a child;

• A brother, sister, stepbrother, or stepsister;

• The father or mother, or ancestor of either;

• A stepfather or stepmother;

• A niece or nephew;

• An aunt or uncle; and

• A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.

If Mary, Karen and Brian were not members of the real estate partnership (say they leased space from someone else), then this problem would not arise.

[1] Edward K. Zollars, CPA, “IRS Releases Additional Guidance on the Employee Retention Credit, And It's Not Good News for Majority Shareholders,” Current Federal Tax Developments website, August 4, 2021, https://www.currentfederaltaxdevelopments.com/blog/2021/8/4/irs-releases-additional-guidance-on-the-employee-retention-credit-and-its-not-good-news-for-majority-shareholders (retrieved August 6, 2021)