Can an S Corp Owner Claim the Employee Retention Credit?

The Employee Retention Credit (ERC) is a refundable tax credit established by the CARES Act to help businesses that retained employees during the COVID-19 pandemic. For owners of S corporations, determining eligibility for the credit on their own wages involves navigating a specific set of rules that are distinct from those for regular employees. This requires a careful review of the business’s situation and the owner’s relationship to the company.

General ERC Eligibility for the Business

An S corporation must meet one of two tests to qualify for the ERC. The first is demonstrating a significant decline in gross receipts. For 2020, this meant gross receipts in a calendar quarter were less than 50% of the same quarter in 2019. For 2021, the requirement was a 20% decline in gross receipts for a quarter compared to the same quarter in 2019.

The second path to eligibility is a full or partial suspension of business operations due to a government order related to COVID-19. A partial suspension applies if an order imposed restrictions with more than a nominal impact on operations. For example, a restaurant forced to close indoor dining and operate only through takeout, or a retail store required to limit occupancy in a way that impacted its normal functions, would qualify.

The government order must be a specific directive from a federal, state, or local authority that limited commerce, travel, or group meetings. General advice from government agencies does not meet this standard. The suspension must be directly attributable to the order, not a voluntary decision by the owner. Once a business establishes eligibility, it can then assess which wages qualify.

Determining if an S Corp Owner’s Wages Qualify

Once the S corporation qualifies for the ERC, the next step is determining if the owner’s W-2 wages are “qualified wages.” This depends on the IRS’s “related individual” and “constructive ownership” rules. These rules are designed to prevent business owners from claiming the credit on wages paid to themselves or their close relatives.

Under these attribution rules, an individual is treated as owning stock that is also owned by their family members, including a spouse, children, grandchildren, parents, and siblings. An S corporation owner’s percentage is calculated by adding their direct stock ownership to any stock owned by these relatives. If this combined ownership exceeds 50%, the owner is considered a majority owner, and their wages are not eligible for the credit.

For example, if an S corp owner directly owns 40% of the company stock and their adult child owns 15%, the owner is treated as owning 55% (40% + 15%). Because this exceeds the 50% threshold, the owner’s wages do not qualify for the ERC. This disqualification applies based on the relationship and stock ownership alone, regardless of the relative’s involvement in the business.

A narrow exception exists. If a majority owner has no living relatives as defined under the attribution rules—no spouse, ancestors like parents, or lineal descendants like children—their wages and their spouse’s wages may qualify. In contrast, the wages of a minority shareholder, one who owns 50% or less of the S corp including attribution from relatives, may be eligible for the credit. Ownership structure and family relationships are a central factor in an owner’s eligibility.

Calculating the Credit and Required Documentation

The credit calculation rules differ between 2020 and 2021. For 2020, the credit is 50% of the first $10,000 in qualified wages paid to an employee for the entire year. This results in a maximum credit of $5,000 per employee.

For 2021, the credit rate increased to 70% of qualified wages, and the wage limit was applied quarterly. For each of the first three quarters of 2021, an employer could claim 70% of the first $10,000 in qualified wages paid to an employee. This allows for a maximum credit of $7,000 per employee per quarter, or $21,000 for the year. Qualified wages include salary and certain employer-paid health plan expenses.

To substantiate an ERC claim, the IRS requires that comprehensive documentation be maintained. This includes:

• Quarterly payroll tax filings (Form 941) for the periods claimed.
• Detailed payroll records showing the wages paid to each employee, including the owner.
• Financial records, such as profit and loss statements, to prove a decline in gross receipts.
• Copies of the specific government orders that caused a business suspension, if eligibility is based on this test.

How to Claim the Credit

The Employee Retention Credit is claimed retroactively by filing Form 941-X, Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for Refund. The deadline to amend returns for 2020 wages has passed. For wages paid in 2021, the final deadline to file a claim is April 15, 2025.

A separate Form 941-X must be filed for each quarter the credit is claimed. Due to concerns about fraudulent claims, the IRS implemented a moratorium on processing new ERC applications submitted on or after September 14, 2023. This means claims filed for 2021 before the deadline will face heightened scrutiny and significant processing delays.

When completing Form 941-X, filers must provide a detailed explanation of how they determined eligibility and calculated the credit. After the form is mailed to the appropriate IRS service center, the review process can be lengthy. Upon approval, the IRS issues a refund check for the credit amount.