Why the Employee Retention Credit (ERC) Remains Frequently Overlooked by Charitable Organizations

FORT LAUDERDALE, Fla., July 18, 2023 /PRNewswire/ -- 

Key Takeaways:

• Many U.S. charitable organizations have dismissed the possibility of Employee Retention Credit ("ERC") eligibility due to stable or increased revenues over the tested eligibility period (i.e., 2020 – 2021).
• The "first" ERC eligibility test introduced by Congress was an operational test dubbed the "full or partial suspension of operations" or "FPSO" test and looks specifically to COVID-19-related impacts on an organization's ability to perform their normal-course services, despite government-mandated restrictions.
• The fact that a charitable organization's donor base may have stepped up during the onset of the pandemic and sustained the organization's revenues does not disqualify such it from ERC eligibility, as the design of the ERC was meant to encourage employers to deploy available financial resources toward retaining employees amid an operational disruption, rather than to supplement or replace lost revenues.
• A "small employer" of fewer than 100 full-time employees for the 2020 test or 500 full-time employees for the 2021 test (both using CY2019 as the testing period), need only show that a more than "more than nominal" operational effect was experienced within a "portion" of the organization's service platform, but is not required to show that impacted employees were retained during the affected period.
• Charitable organizations and other non-profit leaders may wish to consider tax insurance or ERC financial guarantees, to mitigate risk and to ensure the outcome of an ERC claim.

ERC, Charitable Organizations, and Revenues

Charitable organizations that are tax-exempt under IRC Section 501(c)(3) may arguably be the most confusing category of "eligible employers" to analyze under the ERC rules. With a revenue-reduction test front and center of most preliminary ERC discussions, it is without surprise that many charitable organizations often quickly dismiss the possibility of eligibility in the very common case where their donors bridged the giving gap during the COVID-19 pandemic to normalize, or often increase, their contribution revenues.

However, in peeling back the onion behind the ERC legislative intent behind the "full or partial suspension of operations" or "FPSO" test (often referred to as the "business disruption" test), it becomes more obvious that the purpose of the intent behind the test was to capture the reality that, "the revenues do not always tell the full story." This statement is almost always true for charities and other nonprofit organizations.

The Two Eligible Employer Tests

Digging into eligibility, it may be useful to point out that the first eligibility test mentioned in the CARES Act was the FPSO test, with the second test being the "significant decline in gross receipts" or "SDGR" test. In effect, the SDGR test functions as a de facto, accounting-based "safe harbor" that affords an organization that completes the mathematical exercise virtual certainty on eligibility. In effect, an SDGR-eligible employer can bypass the need to show an actual operational disruption due to the fact that their gross revenues were so significantly disrupted. 

So why might Congress have led off with FPSO in defining the two possible paths to eligibility? Because the revenues, particularly in the case of charitable organizations, do not always tell the full (operational) story. 

Inversely Correlated Revenues to Units of Service

The fundamental nature of how charitable organizations function is that their primary source of revenues, charitable contributions, are often not closely correlated to their operational output, typically units of charitable service to further the charitable missions. During the COVID-19 pandemic, it was extremely common for charitable organizations to experience revenue stability or even growth that was inversely correlated to their operational output. 

According to studies conducted by Giving USA, "[i]n 2020, Americans gave $471.44 billion to charity, a 5.1% increase over 2019."¹ Despite the pandemic persisting well beyond 2020, the same study found that "[i]n 2021, Americans gave $484.85 billion to charity, a 4.0% increase over 2020."²

"Revenue Replacement" vs. "Employee Retention"

Both not-for-profit and for-profit organization leadership often express their concern that the SDGR test must indicate that the ERC was intended to replace lost revenue. It's important in these situations to remind these decision makers of the name of this specific stimulus program: the Employee RETENTION Credit. 

Unlike the Payroll Protection Program ("PPP"), which proactively provided businesses with a cash infusion to maintain payroll, the ERC was put in place to provide a monetary incentive in the form of a payroll tax refund to employers to retain employees whose wages weren't otherwise funded with PPP funds. 

The ERC legislation reflects the reality that just because an organization, whether non-profit or for-profit, has the financial wherewithal to pay wages and retain employees, does not mean that they will actually do that in the event that temporary, but fundamental, changes occur with respect to the operations of an organization. The ERC was instituted to further encourage such employers to continue paying employees amid operational disruptions by effectively covering 50% - 70% of the cost of retaining the employee. 

The often-awkward result for "small employers" (<500 FTEs in 2019) under the ERC is that there is no requirement that such employers demonstrate they retained some or all of their employees over the qualifying period; there is only the obligation to show that an operational change occurred that might have sparked the need to make decisions surrounding employee retention. This is to be contrasted with the requirement for "large employers" to show they paid employees for idle or non-working time, reflecting Congress's apparent decision to reduce the administrative burden on small businesses.

While the September 30, 2021, cutoff date for the ERC has long since expired, charitable organizations are still able to retroactively claim the ERC, provided they meet one of the two tests above. While most charitable organizations meeting SDGR in one or more quarters have likely already claimed some ERC, there is no time like the present to reevaluate whether the operational-based, FPSO test, is a viable path toward ERC eligibility during any quarter an organization suffered operationally due to COVID-19 executive order mandates. This result is often the case, even while experiencing stable or increased revenues.

Tax Insurance or Guarantees with ERC

Currently, there is a limited but available market for either tax insurance or financial guarantees that can be coupled with an ERC claim. In basic terms, these products ensure the financial outcome of an ERC if the IRS denies an ERC claim or reverses an ERC claim under audit. These products can also be used to eliminate the risk of penalties or interest and typically must be accompanied by a third-party legal opinion to satisfy the underwriting requirements. 

Due to the "zero risk" tolerance nature of charitable organizations and their boards, these products have been very popular with a select number of charitable organizations that have secured them. A successful underwriting process, which includes a detailed review of the ERC eligibility position and calculation, is required. Unsurprisingly, there are a very limited number of insurance companies that are offering these types of products and such providers will only work with a highly vetted group of tax and legal professionals. 

EZ-ERC's Recommendation

We encourage all leaders of charitable organizations to give a "second look" to eligibility, so they can maximize the amount of available government resources that make their way into the right hands. Those looking to eliminate any iota of financial and reputational risk should strongly consider whether an insurance or guarantee product may be available to them. 

EZ-ERC has worked with over 250 non-profit organizations and has successfully facilitated over $30 million in ERC tax insurance policies. Please reach out to our highly experienced teams of CPAs and lawyers to learn more about their deep expertise and credentials working with charitable organizations across the country towards successful ERC claims.

Author: EZ-ERC CEO Kenneth Dettman, CPA

¹ Giving USA 2020 Annual Report
² Giving USA 2021 Annual Report

Media Contact: [email protected] 

SOURCE EZ-ERC