How nonprofit organizations are missing out on employee retention credit benefits
Find out how nonprofit organizations are missing out on employee retention credit benefits, and what you need to know before seeking help.
Most laypeople aren’t aware that there are many different types of NPOs – around three dozen categories created by Congress – and the term “nonprofit” is often used to describe them all. “Nonprofit,” as many leaders know, just means that the organization is not operating primarily to make a profit to benefit shareholders.
The main goal of a 501(C)(3) organization is to further a specific social cause. The purpose of NPOs is fairly straightforward, but information regarding NPOs and tax benefits can be complex and daunting – even for a seasoned executive. This is especially true regarding the benefits of different COVID-19 relief programs, where misconceptions lead NPOs to believe they can’t qualify for funds when the reality is that NPOs are not barred from claiming the tax credit.
In 2021, charitable giving reached $471 billion, leading many NPOs to assume they wouldn’t qualify for COVID-19-era CARES Act benefits due to the lack of revenue decline. One of those benefits is the Employee Retention Credit (ERC). The ERC, applicable to tax years 2020 and 2021, offers relief from certain employment taxes to support businesses that retained employees during the pandemic.
Many businesses did not take advantage of the Employee Retention Credit due to confusion surrounding qualifications. The Internal Revenue Service (IRS) issued guidance related to eligibility in 2021, eliminating some confusion related to the ERC. Still, misconceptions about the ERC remain and have made the filing process challenging to navigate without qualified assistance.
One common misconception is that NPOs do not qualify for the Employee Retention Credit. Nonprofit leaders may be hesitant to apply for the ERC due to the risk of an IRS audit or the potential adverse public reaction to filing despite a spike in charitable giving. However, NPO leaders will be pleased to know that their organization may still qualify for the tax credit – even absent a loss in revenue for 2020 and 2021 – and can still safely apply for the benefit by consulting ERC experts.
Eligibility misconceptions for nonprofits
As noted above, many NPO leaders avoid applying for Employee Retention Credit benefits because they assume their organization won’t meet the eligibility requirements. However, there are two avenues of eligibility for ERC – and only one needs to be met.
The first test focuses on whether or not the employer or organization experienced revenue loss, which is why NPO leaders avoid the ERC. However, there is a second route to ERC eligibility under the partial suspension of operations test, which reviews how COVID-19 related state and local orders impacted the organization’s operational output and does not consider revenue in the analysis. The full or partial suspension of operations test (FPSO) is not a financial statement test – so an NPO is not required to have any decline in gross receipts to prove the existence of an FPSO.
The FPSO test was created with several core ideas in mind. First, gross receipts do not always illustrate the full picture of an organization’s experience with COVID-19 and hardship.
A recent study found that the US nonprofit sector lost over 900,000 jobs during the pandemic and created financial hardship for many nonprofit organizations by impacting donor intent, revenue from fee–for–service programs, and grant funding. Each nonprofit sector was affected differently. For example, healthcare had the lowest job losses of −3.7%, while arts, entertainment, and recreation experienced more extreme losses of −34.2%.
Second, profitable businesses may have had to make difficult staffing and employee retention decisions due to COVID-19-related changes to their business, despite not experiencing an immediate loss in revenue.
For example, an organization may be successful in one department but not another, leading to a total revenue increase while certain business service lines suffered The ERC was not intended to be a revenue replacement. Rather, the Employee Retention Credit was created to encourage the retention of employees in both profitable and non-profitable businesses, as well as reward organizations that were able to retain their employees during the economic downfall caused by COVID-19.
Another reason NPO leaders are hesitant to apply for the tax credit is the potential for negative reactions from boards, shareholders, and the public.
The Paycheck Protection Program (PPP) served as an example of what could happen if the media catches wind of businesses fraudulently claiming government funds and tax credits. The PPP offered potentially forgivable government loans to small businesses and was fairly easy to obtain. However, some of the funds were distributed to companies owned by public figures, as well as companies that thrived during COVID-19.
The PPP was established by the CARES Act to prevent economic downfall during the pandemic and provide small businesses with funds to pay up to eight weeks of payroll costs.
Unlike the PPP, the Employee Retention Credit is neither a revenue replacement nor a loan, which is why NPOs should investigate their eligibility for funds they may be entitled to. The ERC is meant to reward businesses – including NPOs – that meet the eligibility requirements and retained employees during a time of unprecedented economic and operational distress, regardless of revenue.
The benefit of applying for the employee retention credit as a nonprofit
NPOs are generally restricted in terms of how they can spend donated funds. Personal contributions can be limited to one family, scholarship, or event, and grant funds might only be allowed for materials, reporting, or operational costs. Funds from the Employee Retention Credit are unrestricted – meaning NPOs can use the funds to support any program or objective within the organization.
Access to non-restricted funds can alleviate the burden of impacted services and can be used to create or support flexibility in new services or programs where your nonprofit’s mission can make the most significant impact. If executed correctly, claiming the tax credit can be done transparently and can benefit the NPO as a whole.
Many nonprofit leaders remain unaware of the Employee Retention Credit and their organization’s eligibility. There is still time to claim the ERC – a nonprofit-eligible employer can claim the CARES Act ERC for a total of seven quarters, beginning March 13, 2020, and ending on September 30, 2021, depending on each organization’s circumstances.
Because the Employee Retention Credit and the CARES Act are complex and require in-depth knowledge to determine eligibility, NPO leaders should consult with experienced tax and legal professionals to avoid potential audits or ERC scams, which were added to the IRS Dirty Dozen list.
Choosing the right third-party ERC firm is a tricky yet imperative step when considering applying for ERC funds as an NPO. If you want your organization to gain all the benefits of claiming the ERC without the risk associated with potential audits, you need experts on your side.
Key considerations when searching for the right firm for your organization
Here are some key considerations to keep in mind when searching for the right firm for your organization:
- Start-to-finish assistance. The right ERC firm will offer assistance throughout the entire process of revisiting your filings, including calculating, documenting, claiming your ERC, and audit support.
- Tax insurance experience. Find a firm that has established strong, long-standing relationships with insurance brokerages that have the resources to identify tax insurance policies.
- IRS experience. The right ERC firm for your NPO will have experience dealing with – and proactively preparing for – audits.
- Paid preparer signature. Look for firms that take ownership of and coordinate the submission of forms to the IRS.
- Law firm relationships. Seek firms that employ both tax and legal professionals. Attorneys are crucial to ensuring full compliance with the law as an NPO.
- Accountability. Avoid firms that include ultra-broad cautionary disclaimers related to liability for providing tax or accounting advisement. The right firm for your organization will take ownership of what service they are providing
- Low fees. The sweet spot for not overpaying – but still employing qualified ERC experts – is in the 10-20% range, depending on the size and complexity of your business.
Once your organization obtains its unrestricted ERC funds, you can get back to doing what you do best as a non-profit organization – advocating for your mission and making a difference in the communities you serve.
