Dan Chodan CPA provides us with more on the related party rules of ERC.

Congress often cites existing law to provide certain definitions for new laws. The results can create a tangled web of cross references and often produce interesting results. We recently explored one of these unusual aspects of ERC definitions as it relates to owners being disqualified by nature of the family attribution rules of Sec. 267(c) in this article. However, the attribution rule complexity does not stop there. Section 267(c) defines multiple sets of attribution rules which will determine who is a more-than-50% owner for ERC purposes resulting in disqualification of certain relatives.

In this article, we will review how to apply the relevant attribution rules to determine the relatives disqualified for ERC. The result is that any relative of any owner might be disqualified for ERC regardless of the portion of direct ownership an owner holds.

Family attribution of ownership

Sec. 267(c)(2) causes ownership to be attributed between the direct owner and the owner’s brothers and sisters (whether by whole or half blood), spouse, ancestors, and lineal descendants. This attribution of ownership occurs regardless of whether the family member owns any portion of the business under Regs. Sec. 1.267(c)-1. As a result, family attribution rules create many indirect owners of a business because they are related to the direct owners of a business. Family attribution also may cause an owner with only a small portion of direct ownership to have a much larger portion of direct and indirect ownership.

Partner-to-partner attribution of ownership

Sec. 267(c)(3) causes ownership to be attributed between direct owners when those owners are also partners. So an owner may have both direct and indirect ownership if they own multiple entities. It is important to note that reattribution is not permitted after family attribution or partner-to-partner attribution occurs under Sec. 267(c)(5). This means ownership that is attributed partner-to-partner cannot then be reattributed by family attribution and vice versa. This put defined limits around attribution rules to keep the ownership from continually attributing on and on indefinitely.

Who are relatives of owners?

Sec. 152(d)(2) defines relatives for the purposes of ERC and was reiterated by Notice 2021-20. Disqualified relationships to a greater-than-50% owner include the following:

• A child or a descendant of a child;
• A brother, sister, stepbrother, or stepsister;
• The father or mother, or an 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.

Analysis and examples 

It is difficult to understand how all of these rules work together until you apply real-world examples. Let’s look at various situations where a business is eligible for ERC and is now performing an analysis to determine which wages are allowed for the credit.

Let’s begin with a business where four unrelated owners each own a 25% share and employ their children. Family attribution rules will not apply between the owners as the owners are unrelated. As a result, the children’s wages are allowed for ERC as they are not related to a greater-than-50% owner.

Next let’s look at a family business where four brothers each own a 25% share and employ their children. At first, we might think that there is no greater-than-50% owner to create disqualified relative wages. However, we must apply family attributions rules first. Since siblings are attributed each other’s ownership under Sec. 267(c)(2), we determine that each brother is in fact a 100% owner of the business directly and indirectly. Because the children have a disqualified relationship to a greater-than-50% owner, the children’s wages will not be eligible for the ERC.

Returning to the first situation but adding one fact can change the results. Let’s again look at a business where four unrelated owners each own a 25% share and employ their children. Family attribution rules will not apply between the owners as the owners are unrelated. However, the owners also own the business real estate in a separate partnership. So in this case, the partner-to-partner attribution rules apply. Each owner is attributed the ownership of the business held by their partner. Each owner is in fact a 100% owner of the business directly and indirectly under Sec. 267(c)(3). Because each owner’s children have a disqualified relationship to a greater-than-50% owner, the children’s wages will not be eligible for the ERC. The very common decision for an ownership group to purchase real estate together in partnership creates a trap for disqualifying relative’s wages.

Lastly let’s look at an example to illustrate applying both sets of rules and limitations of reattribution. An S-Corporation is owned by sisters A and B and by brothers C and D with each owning 25% of the S-Corporation. The sisters are not related to the brothers. B and C have decided to buy the business real estate together in a separate partnership. In this example, both the family and partner-to-partner attribution rules apply. A and B’s ownership attributes to each other as sisters. C and D’s ownership attributes to each other as brothers. B and C’s ownership attributes to each other as partners. The full results of both sets of attribution are shown below.

The relatives of B and C are ineligible wages for ERC as disqualified relationships to a greater-than-50% owner. However, any relatives of A and D are okay and still eligible for ERC because A and D are not greater-than-50% owners.

Note that B receives C’s 25% ownership via partner-to-partner attribution but does not pass the same 25% on to B’s sister A. This is the limit on reattribution. Direct ownership is attributed to others, but indirect ownership by family or partner-to-partner attribution cannot be attributed again.

Full evaluation of related entities and ownership is necessary 

It may be simple to understand who is a relative of a greater-than-50% owner, but it is often complex to determine who are greater-than-50% owners themselves. Advisers should gather information on all related entities and related individuals to make a full analysis of ownership attribution. Ultimately, a relative of any owner can be at risk ERC wage disqualification.

 Dan Chodan, CPA is a partner at Trout CPA in Lancaster, PA.