Can Independent Contractors Claim the ERC?
Your business structure is the key to ERC eligibility. Learn how the rules apply differently to sole proprietors and incorporated business owners.
The Employee Retention Credit (ERC) was established as part of the economic response to the COVID-19 pandemic. It was designed as a financial incentive for businesses to keep their employees on the payroll during a period of economic uncertainty. The rules surrounding this refundable tax credit have caused confusion, particularly for independent contractors and other self-employed individuals.
ERC Eligibility for Independent Contractors
Independent contractors and self-employed individuals who operate as sole proprietors are generally not eligible to claim the ERC for their own earnings. The credit is calculated based on qualified wages paid to employees, which are payments subject to Social Security and Medicare taxes and reported on Form W-2. An independent contractor’s income is reported on Form 1099-NEC and does not meet the definition of qualified wages.
The credit’s purpose was to encourage employers to retain their workforce. A self-employed individual without employees does not have a payroll and therefore has no employees to retain. While a business owner who hires W-2 employees could claim the ERC for those employees’ wages, they cannot claim it for their personal self-employment income. Similarly, a business cannot claim the ERC for payments made to an independent contractor.
The credit was available for wages paid between March 13, 2020, and December 31, 2021. To qualify, an employer must have experienced either a full or partial suspension of operations due to a government order or a significant decline in gross receipts. A significant decline was defined as a 50% drop in gross receipts for a 2020 calendar quarter compared to the same quarter in 2019. For 2021, the threshold was a 20% decline.
The Exception for Incorporated Business Owners
A specific exception exists for business owners who have structured their business as an S Corporation or a C Corporation. In this structure, an individual can be both the owner and an employee of their own corporation. The owner-employee receives a reasonable salary for their work, which is processed through payroll and results in a Form W-2.
Because the owner is a formal employee receiving W-2 wages, the corporation, as the employer, may be able to claim the ERC on those wages. The claim is made by the business entity, not the individual owner, and the business itself must meet the eligibility criteria. This means the corporation must have experienced the required decline in gross receipts or a suspension of operations.
The wages paid to the owner-employee must be considered qualified wages. For businesses with 100 or fewer full-time employees in 2019 (for the 2020 credit) or 500 or fewer (for the 2021 credit), all wages paid to employees are generally eligible. However, the credit cannot be claimed on the same wages that were used to obtain forgiveness for a Paycheck Protection Program (PPP) loan.
Alternative COVID-19 Tax Credits for the Self-Employed
While the ERC was not available for the earnings of most independent contractors, other relief was specifically created for them. The Families First Coronavirus Response Act (FFCRA) and the American Rescue Plan Act (ARPA) established tax credits for sick and family leave for certain self-employed individuals. These credits were designed to mirror the benefits provided to employees of larger companies.
These credits allowed eligible self-employed individuals to receive a refundable credit against their income tax if they were unable to work for reasons such as:
- Being subject to a quarantine order
- Experiencing COVID-19 symptoms
- Caring for an individual subject to quarantine
- Caring for a child whose school or place of care was closed due to the pandemic
To claim these credits, self-employed individuals used Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals, filed with their annual Form 1040. The amount of the credit was based on the individual’s average daily self-employment income. For qualified sick leave, the credit was capped at $511 per day for up to 10 days.
These credits were only available for specific periods during 2020 and 2021, and the deadlines for original tax filings have passed. However, individuals who were eligible but did not claim the credits on their original tax returns may still be able to file an amended return. This is subject to the standard statute of limitations for amendments.