Employee Retention Credit for Nonprofits: Understanding the Basics

The COVID-19 pandemic has created financial challenges for organizations across all industries, including in the nonprofit sector. As a nonprofit director, you have likely faced tough decisions to reduce expenses and retain a payroll budget to support your critical mission and dedicated employees. The employee retention tax credit provides helpful payroll funding at such a crucial time. This article explains how nonprofits can utilize the credit to continue serving communities and compensating staff.

What is the Employee Retention Credit for Nonprofits?

The employee retention credit is a beneficial payroll tax credit that provides incentives for employers to keep employees during pandemic-related business disruptions.

CARES Act Creation of the Credit

This tax credit was established in March 2020 by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as COVID-19 first necessitated widespread business closures. The CARES Act assisted companies in weathering the pandemic storm.

Follow-Up Legislation Extending the Credit

Given the positive financial impacts realized by employers, the employee retention tax credit was then extended and expanded through 2021 by subsequent COVID relief legislation:

Taxpayer Certainty and Disaster Tax Relief Act

This Act passed in December 2020, extended the credit for the first two quarters of 2021.

The American Rescue Plan Act

The American Rescue Plan Act of March 2021 then extended the credit once more through the third calendar quarter of 2021.

With each extension, eligibility requirements and potential credit amounts were enlarged to provide even greater benefits.

Can Nonprofits Claim the Employee Retention Credit?

The credit was designed to be broadly applicable to for-profit companies and tax-exempt organizations alike.

Tax-Exempt Organizations Qualify

Employers operating under section 501(c) of the Internal Revenue Code, including 501(c)(3) and 501(c)(6) entities, can claim the credit.

501(c)(3) Public Charities

This encompasses public charities like churches, schools, hospitals, arts organizations, and other social benefit nonprofits.

501(c)(6) Business Leagues and Trade Associations

Industry and professional member associations also qualify as 501(c) tax-exempt organizations.

In addition to tax-exempt status, any employer that experiences certain pandemic impacts can qualify:

Partial Suspension of Operations

If a nonprofit had to fully or partially shut down operations due to a government public health order, it can claim the credit for the duration of the suspended operations. Even operating on a limited basis qualifies.

The Decline in Gross Receipts Threshold

Eligibility also extends to employers who faced a significant decline in gross receipts of at least 20% compared to the same quarter in 2019. Nonprofits severely impacted by decreased donations and revenue drops due to COVID-19 fall under this threshold.

Requirements for Nonprofit Eligibility

To claim the credit as a nonprofit organization, you must satisfy the following:

Documentation of Active Tax-Exempt Status

You must have a valid 501(c) tax exemption status in effect during the quarter for which you claim the credit. This is documented through your IRS determination letter.

No Minimum Number of Employees

There are no rules in 2021 related to a minimum number of employees, maximum employees, or average full-time equivalents (FTEs). Any size nonprofit can qualify.

Relaxed Eligibility Rules for 2021

The 2021 credit requirements were broadened so that nonprofit employers of any size can claim the maximum benefit.

More restrictive rules applied in 2020 regarding larger nonprofits, but those no longer apply.

Employee Retention Credit Amounts for Nonprofits

The maximum benefit increased substantially from 2020 to 2021:

2020 Maximum Credit Per Employee

For 2020, nonprofits could claim up to $5,000 per employee for the full year.

Increased 2021 Credit Amount

This credit amount per employee rose to up to $7,000 per quarter in 2021. This equates to a potential $28,000 per employee credit for 2021.

Quarterly Per Employee Credit Calculation

The credit equals 50% of qualified wages paid to an employee in a quarter, up to $10,000 in wages. So with a maximum of $10,000 in qualified wages paid, the resulting credit would be $5,000.

Claiming the Credit on IRS Form 941

Completing and Filing Form 941

To claim the credit, nonprofits complete Form 941 quarterly payroll tax returns. The credit amount reduces the employer’s share of Social Security tax reported on Form 941.

Requesting Advance Credit Payments

Rather than waiting to file Form 941 at quarter-end, employers can file Form 7200 to request an advance payment of the anticipated credit amount.

Timing of Advance Payment Receipt

These advances are typically paid within 2 weeks of submitting Form 7200 for qualified employers. This provides liquidity to immediately offset payroll expenses.

Definition of Qualified Wages for Nonprofits

Certain wages paid to employees qualify for the credit calculation:

Paid Leave Wages Qualify for the Credit

Wages paid to compensate employees not working due to COVID-19-related circumstances are eligible, including emergency paid sick and family leave.

Furloughed Employees’ Wages Are Eligible

Compensation paid to furloughed workers also qualifies. This allows nonprofits to retain staff during times of reduced activity.

Special Rules for Religious Nonprofits

The only exception is for religious organizations, where wages paid to ministers or employees earning over $1 million annually do not qualify.

Coordination of the Credit with PPP Loans

If your nonprofit applied for a Paycheck Protection Program loan during the pandemic, coordination is required to maximize benefits but prevent duplicating the same wages:

Preventing Double-Dipping on Wages

Wages already paid for with a PPP loan cannot count again toward the retention credit. Only additional qualified wages beyond the loan amount can qualify.

Strategic Timing of PPP Loan Forgiveness

To optimize benefits from both programs, it is advisable for nonprofits to first claim qualified wages for the credit in 2020 and early 2021 before applying for PPP loan forgiveness.

Other Important Considerations for Nonprofits

A couple of additional points to note:

Refundability of Unused Credits

If your calculated credit amount exceeds your payroll tax liability for the quarter, the IRS will issue a refund check to your organization for the balance.

Maintaining Proper Documentation

Be sure to keep detailed records including 501(c)(3) determination letters, qualified wage documentation, FTE counts, and gross receipt decline calculations to support the credit claimed.

Conclusion

The employee retention tax credit provides a lifeline for strained nonprofits working to retain employees amidst pandemic challenges. Make sure to consult your legal and tax advisors to confirm your specific eligibility. With proper planning around your unique situation, this credit could offer critical funds to continue your nonprofit’s invaluable community contributions. Please reach out with any other questions!

FAQs

Q: Are there filing deadlines to claim the credit?

A: Yes, Form 941 must be filed by the filing deadline for that quarter to claim the corresponding credit.

Q: Can wages paid with PPP loan money qualify if it is later forgiven?

A: No, wages paid from a PPP loan do not become eligible for the credit even after the loan is forgiven.

Q: How long will it take to receive a refund for excess credits?

A: Excess credit refunds are typically issued within 3-4 weeks after filing Form 941 showing the overpayment.

Q: Can nonprofits claim both the employee retention credit and other payroll credits?

A: Yes, nonprofits can claim multiple payroll credits such as the paid leave credits, just not on the same wages.

Q: Can nonprofits amend past returns to claim the credit?

A: Yes, Form 941-X can be filed to claim credits on qualified wages paid in prior quarters within the statute of limitations.

Here are two relevant links to studies and commentary related to the article on the employee retention tax credit for nonprofits:

Nonprofit Eligibility for the Employee Retention Tax Credit

This page from Independent Sector, a nonprofit leadership network, provides an overview of eligibility rules and considerations specifically for nonprofits claiming the tax credit. It summarizes guidance from IRS notices and outlines documentation requirements.

The Importance of Retaining Employees During COVID-19

This commentary piece from Nonprofit Quarterly discusses the challenges nonprofits face retaining staff during COVID-19 budget cuts and remote work transitions. It highlights why maintaining experienced employees should be a priority despite cost-cutting pressures.

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