The ERC was first enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, then modified and extended by the Consolidated Appropriations Act (CAA) in December of the same year. In March 2021, Congress extended the ERC through the remainder of 2021 via the American Rescue Plan Act (ARPA). The IRS recently released guidance highlighting many nuances of the credit and in particular certain aspects, which differ for tax-exempt organizations in contrast to for-profit entities. This article will focus on these nuances.
As we discussed in our article, "New employee retention credit opportunities exist for 2020 and 2021", qualification for the ERC is based on either proving a significant decline in gross receipts between comparable quarters post-pandemic (2020 or 2021) and pre-pandemic (2019) or documenting a partial or complete suspension of operations. Once an employer qualifies for the credit, it calculates its credit in different ways depending on whether it’s a large employer or small employer as defined. For 2020, a small employer is one that employed 100 full-time employees (FTEs) (as defined) or fewer during 2019. For 2021, a small employer is one that employed 500 or fewer FTEs in 2019. As the related article indicates, employers can qualify for up to $5,000 per employee in 2020 and $7,000 per employee per quarter in 2021.
Gross receipts measurement for employee retention credits for nonprofits
The following tests apply to determine whether the employer suffered a “significant decline” in gross receipts:
- For the 2020 ERC: If the gross receipts of any quarter in 2020 were less than 50% of the corresponding quarter of 2019, the ERC is available in that quarter. The ERC is also available in each subsequent quarter of the year, until gross receipts were at least 80% of the corresponding 2019 quarter.
- For the 2021 ERC: If the gross receipts of either of the first two quarters of 2021 are less than 80% of the corresponding quarter of 2019, the ERC is available in that quarter. Employers may elect to use the gross receipts from the prior calendar quarter for this test. For example, to determine ERC eligibility in Q1 of 2021, the employer may compare its gross receipts from Q4 of 2020 to those from Q4 of 2019. Additionally, employers that weren’t in existence in 2019 may compare their 2021 gross receipts to the corresponding quarter of 2020.
For tax-exempt entities gross receipts are measured consistent with Form 990 rules. This includes contributions and programmatic revenue as well as investment income such as dividends and interest and the gross proceeds from any asset sale. It doesn’t include unrealized gains and losses. It also doesn’t include in kind contributions of services or rent. To further complicate matters, gross receipts must be reported on a quarterly basis. Organizations should confer with their professional advisors with any questions about gross receipt measurement.
Full or partial suspension
Many organizations that don’t meet the gross receipts test may argue that they suffered a full or more likely a partial suspension of their operations. The IRS released Notice 2021-20 giving some insight about a “partial suspension.” Under prior guidance, the IRS indicated a partial suspension occurs when COVID-19-related government orders cause more than a nominal portion of operations to be suspended. Notice 2021-20 suggested that modifications resulting in a reduction of 10% or more of the employer’s ability to provide goods or services would be a more than nominal portion of operations. It’s easy to speculate how a “10%-or-more-reduction” standard could be applicable to tax-exempt organizations. We’re hopeful more guidance is forthcoming. We caution organizations to carefully document and assess their rationale for claiming a partial suspension.
Headcount measurement for employee retention credits at nonprofits
The FTE count is the key factor in determining the potential size of an organization’s ERC. As previously noted, different rules apply to small employers as compared to large employers, with the credit being much more lucrative for small employers. Employers determine their size by counting FTEs in 2019.
It’s important to remember here that these counts differ from typical FTE counts:
- The standard is 30 hours per week or 130 hours per month measured on a month-by-month basis for calendar year 2019. Either an employee meets the threshold and is counted as an FTE or they don’t, and they count for zero. An employee working over 30 hours per week is one FTE, but an employee working 15 hours a week is zero FTE, not .5.
- The calculation is an average of the 12 monthly FTE totals. You tally up the employees that meet the FTE requirement each month, and then average that number over the course of the year to determine your number.
- Example 1: Summer Camp has five FTEs nine months out of the year and 1,000 for the other three months. Average monthly FTEs = 254. Summer Camp is considered a large employer for the 2020 credit but is a small employer for the 2021 credit.
- Example 2: Education organization issues 2,000 W-2s, including 1,900 W-2s to tutors who all work on average 20 hours or less per week. The organization also employs 100 staff that provide administrative, managerial, and fundraising services for more than 30 hours per week. Average monthly FTE’s for ERC purposes = 100. Education organization is considered a small employer for both 2020 and 2021.
Aggregation rules
Determination of both gross receipts and FTEs may also be complicated by situations where the employer is related to other entities where, in combination, they may exceed the threshold. The IRS has not issued any FAQs on how to measure aggregation for related tax-exempt organizations. Based on our interpretation of the ERC statute and related IRC regulations, aggregation in the nonprofit sector appears to be required when multiple entities have an 80% control overlap, meaning an 80% direct or indirect overlap in or control of trustee/directors among the entities in a group. Aggregation may also come into play when there is a common mission or overlap in workforce or some other close connection that allows the taxpayers to aggregate for purposes of setting up qualified plans and other permitted benefit plans.
PPP and the ERC
Under the original terms of the CARES Act, any employer who took advantage of a Paycheck Protection Program (PPP) loan was automatically disqualified from claiming the ERC. The CAA eased this restriction retroactively, so that employers who received PPP proceeds in 2020 or 2021 can still claim the ERC. However, wages included in a PPP loan forgiveness application may not be eligible for the ERC calculation. The recent IRS guidance makes clear that careful completion of a PPP forgiveness application to minimize wages applied to forgiveness can help increase wages available to apply to the ERC.
Beware double-dipping
Organizations receiving support from federal, state, and local government should be careful to avoid claiming the ERC on any wages applied directly to a grant arrangement. Similarly, organizations should also be aware of similar restrictions that might exist related to foundation grants used to fund specific employees. We suggest organizations receiving this type of funding carefully consider what limitations they might be subject to and confer with appropriate specialists to evaluate their grants.
Nonprofit tax support
Like any discussion about taxes, the application of these rules to your situation will depend heavily on the individual facts and circumstances of your nonprofit organization. When it comes to COVID-19 relief, that discussion is further complicated by the speed at which targeted legislation is being enacted. If you have questions about how these rules affect your organization or about how any changes to these rules could affect you in the future, please contact your Plante Moran engagement team.
