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.” 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.”
“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 (see: https://www.sagemonttax.com/how-you-may-be-eligible-for-the-erc-even-without-a-decline-in-revenue/).
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.
Sagemont Tax’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.
Sagemont Tax has worked with over 250 non-profit organizations and has successfully facilitated over $30 million in ERC tax insurance policies. We have also assisted nearly 2,500 employers in claiming over $1 billion in total ERC (as of June 2023). 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.
Written by Sagemont Tax CEO Kenneth Dettman, CPA
Here’s what our nonprofit clients had to say about Sagemont Tax:
“My experience with Sagemont Tax was one of those rare business collaborations in which my organization’s needs were not only considered to be of the highest priority, but even after our work together had been completed, Sagemont Tax continued to support us. Our credit came at a crucial time and made it possible for us to sustain operations and even grow. I have nothing but praise for the service, professionalism, and compassion demonstrated by the staff of Sagemont Tax.”
– Dorina Luzardo, CEO & Founder, Angel’s Reach Foundation, Inc.
“Sagemont Tax was exceptional to work with. Our representative carefully answered our many questions about the program and was extremely communicative throughout the process. The professionalism Sagemont Tax’s team demonstrated is why we consistently refer business owners and volunteer organizations their way. We highly recommend contacting Sagemont Tax to see what credits are available to you!”
– Abigail Shuck, Board Member, Boys and Girls Club of Johnson County
“As a risk-averse non-profit organization focused on our community, we were very cautious in our approach to filing for the Employee Retention Credit but the experts at Sagemont Tax eased our concerns. They took on the burden of hiring an outside law firm to provide legal analysis and provide additional assurance to support our position. Sagemont Tax made the process very streamlined and simple, with clear instructions through every step, making data-gathering easy. The current combination of inflation and lack of affordable housing has dramatically increased the need for our services. This refund has made an enormous impact on our mission and allows us to help more members of our community!”
– Lunch Break