How Churches May Benefit from COVID-19 Relief’s Employee Retention Credit

Editor’s Note: On September 14, 2023, the Internal Revenue Service (IRS) announced it has immediately stopped processing new Employee Retention Credit (ERC) claims “amid [a] surge of questionable claims.”

Concerns raised by tax professionals, coupled with aggressive marketing to ineligible applicants, “highlights unacceptable risk to businesses and the tax system,” the agency said.

The IRS will continue processing previously filed claims and pay out claims it approves, it said, but processing times will take longer as the agency applies more scrutiny to address fraud concerns.

The IRS also said it is finalizing details to help entities victimized by “aggressive promoters” who have used repeated advertising and direct-contact methods to entice claim applications without carefully evaluating whether an entity truly qualifies for the credit.

Taxpayers who already have a claim submitted, but fear they were misled–including churches and small businesses–will be eligible for a special withdrawal option as well, the IRS said. It plans to announce details for the option soon.

The IRS said more than 600,000 claims remain unprocessed.

Church Law & Tax will continue to monitor developments.

Update. This article was revised on July 19, 2021, August 6, 2021, and December 2, 2022, to reflect needed changes, clarifications, and new information. It was updated again on February 17, 2023, to remove references to IRS FAQ pages after the agency pulled down those FAQ pages.

If your church, nonprofit, or school either experienced a significant decline in gross receipts and/or fully or partially suspended or reduced any significant part of its operations due to a federal, state, or local government mandate during any calendar quarter since the COVID-19 pandemic was first recognized in the United States, then it may be eligible for a special payment from the federal government.

This special payment is labeled the Employee Retention Credit (ERC). The ERC is provided via a credit against your church’s payroll taxes.

The credit amount could be very significant for your organization if:

Under current law, employers generally have until April 15, 2024, to claim the ERC for the 2020 tax year, and until April 15, 2025, to claim the ERC for the 2021 tax year. However, we generally recommend filing ERC claims sooner rather than later, as it is always possible that the law changes and/or the ERC is repealed.

The ERC is a relief provision originally contained in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act passed into law on March 27, 2020.

The Relief Act of 2020, enacted as a part of the Consolidated Appropriations Act of 2021 (CAA) and passed in late December 2020, made significant changes to the ERC. The most significant change from the CAA was that the ERC became available to Paycheck Protection Program (PPP) borrowers, subject to other eligibility requirements, and with the requirement that wages funded by forgiven PPP loan proceeds cannot be used as a basis for the ERC.

About three months later, the American Rescue Plan Act of 2021 (ARPA), enacted on March 11, 2021, created Internal Revenue Code Section 3134, which provides an ERC for wages paid from July 1, 2021, through December 31, 2021.

The ERC is essentially relief/stimulus money paid by the government to eligible employers.

Eligible employers claim the ERC as a credit against certain employer payroll taxes on their Form 941 for the applicable calendar quarter(s). The credit is refundable.

This means that if the employer qualifies for a credit that exceeds the applicable employer payroll taxes against which it is claimed for the applicable quarter, the excess credit is first used to reduce the employer’s required payroll tax deposits for all other federal payroll taxes. Any excess beyond required federal payroll tax deposits is refunded to the employer in cash.

The credit has no actual relationship to the employer-paid payroll taxes against which it is claimed. Claiming the credit against these employer payroll taxes on Form 941 is simply the government’s delivery method for transferring funds to eligible employers.

In March and April of 2021, the Internal Revenue Service (IRS) released Notice 2021-20 and Notice 2021-23, providing guidance regarding the ERC that applies from March 13, 2020, through December 31, 2020, and from January 1, 2021, through June 30, 2021, respectively. ARPA extended the ERC from July 1 through December 31, 2021. In August of 2021, the IRS released IRS Notice 2021-49 providing guidance regarding the ERC that applies from July 1 through December 31, 2021 (except for recovery start-up businesses). Therefore, with limited exception, the 2021 version of the ERC is only available from January 1, 2021, through September 30, 2021.

Also of note: The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted as a part of the CAA in late 2020, also created a separate ERC for wages paid or incurred by nonprofit employers located in qualified disaster zones after the nonprofit employer’s business became inoperable because of damage from a 2020 qualified disaster.

To claim the ERC for a prior quarter for which the church has already filed Form 941, the church must file a Form 941-X (an amended Form 941) for the applicable quarter(s). Special rules provide that the ERC for the first quarter of 2020 is claimed on the Form 941 or Form 941-X for the second quarter of 2020.

What follows is a summary of the ERC requirements and rules, as modified and interpreted by the CAA, ARPA, and IRS Notices. Note that entities which are part of a controlled group of entities are generally aggregated in making all determinations and calculations.

As noted above, churches currently can evaluate their eligibility for the ERC for at least three different time periods: March 13, 2020, through December 31, 2020; January 1, 2021, through June 30, 2021; and July 1, 2021, through December 31, 2021.

This section explains how churches can determine their eligibility for each of the time periods, including steps they can take to retroactively pursue the ERC for time periods that have already occurred.

The following material is designed to help church leaders understand how the ERC works for this time period.

The ERC provides eligible employers—including tax-exempt organizations—a refundable credit against the employer’s share of Social Security tax (the 6.2-percent portion, not the 1.45-percent Medicare tax).

Eligible employers must have carried on a trade or business during 2020 and satisfy one of two economic hardship tests (for tax-exempt organizations described in Section 501(c) of the Internal Revenue Code, all operations of the organization are considered a trade or business for this purpose):

For churches and other nonprofits, the IRS guidance indicates that the term “gross receipts” is defined in the same manner as described in Internal Revenue Code Section 6033, which is interpreted by Treasury Regulations (Reg. §1.6033-2(g)(4)). This means the gross amount received by the church during its annual accounting period from all sources without reduction for any costs or expenses.

Thus “gross receipts” includes, but is not limited to, (i) the gross amount received as contributions, gifts, grants, and similar amounts without reduction for the expenses of raising and collecting such amounts, (ii) the gross amount received as dues or assessments from members or affiliated organizations without reduction for expenses attributable to the receipt of such amounts, (iii) gross sales or receipts from business activities (including business activities unrelated to the purpose for which the organization qualifies for exemption, the net income or loss from which may be required to be reported on Form 990-T), (iv) the gross amount received from the sale of assets without reduction for cost or other basis and expenses of sale, and (v) the gross amount received as investment income, such as interest, dividends, rents, and royalties.

The rules do not appear to make a distinction between restricted and unrestricted contributions with respect to churches and other nonprofit organizations.

Unrealized gains/losses are not included in the definition of gross receipts.

Questions 23 to 28 of Notice 2021-20 provide additional information regarding the determination of whether an organization experienced a significant reduction in gross receipts for purposes of ERC eligibility.

The following example helps illustrate how to apply the criteria described above:

For this time period, the ERC is effective for wages paid after March 12, 2020, and before January 1, 2021.

The ERC is 50 percent of the first $10,000 in qualified wages per employee (including the value of qualified group health plan benefits as further described Questions 40 to 48 of Notice 2021-20). IRS Notice 2021-49 clarifies that an employee’s status as a full-time or part-time employee is irrelevant in determining qualified wages (i.e., qualified wages paid to both full-time and part-time employees are counted in calculating the ERC). Note, however, that wages paid with forgiven PPP loan proceeds may not be used as a basis for the ERC.

Qualified wages are further defined in Questions 30 to 48 of Notice 2021-20, and the ERC’s interaction with PPP loans is further described in Question 49 of Notice 2021-20.

Additionally, Question 58 describes a special rule for claiming an ERC for wages funded by a PPP loan that was not forgiven.

The credit is reduced by any credits claimed for emergency sick pay or emergency family leave pay under the Families First Coronavirus Response Act (FFCRA) or for other credits applicable to the same wages.

To the extent the credit exceeds the church’s Social Security tax due, the excess is considered a refundable overpayment.

For churches with an average of more than 100 full-time employees in 2019, only wages paid to employees for periods during which they were not providing services due to an economic hardship (either (1) a full or partial suspension of operations by order of a governmental authority due to COVID-19 or (2) a significant decline in gross receipts) are eligible for the credit.

For eligible churches with an average of 100 or fewer full-time employees in 2019, wages paid to all employees (regardless of whether they were providing services) during a period of economic hardship (as defined above) are eligible for the credit.

Questions 70 and 71 from Notice 2021-20 provide information regarding documentation that should be kept in an employer’s records as support for the ERC.

Thankfully, few churches, schools, and charities experienced revenue declines in a calendar quarter of 2020 in excess of 50 percent as compared to 2019, so that aspect of ERC eligibility has limited application.

However, churches, schools, and other organizations that were subject to mandatory full or partial suspension of operations or group meetings (including mandatory government orders that required or resulted in capacity limitations in connection with such operations or group meetings, assuming the capacity limitations had more than a nominal effect on the operations) between March 13, 2020, and December 31, 2020, appear eligible for the ERC regardless of whether they were able to continue carrying on certain activities via remote (online) participation.

Applying this interpretation would require the organization to evaluate whether it had “operations that were fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19.”

Such a determination may not be easy to make in every instance since certain safety protocol communications made by government officials or agencies may not have reached the level of authority of “orders.”

Additionally, language in Question 15 from Notice 2021-20 states that if the “employer is able to continue operations comparable to its operations prior to the closure by requiring its employees to telework, the employer’s operations are not considered to have been fully or partially suspended as a consequence of a governmental order.”

While it may be tempting to assume that such language means that churches that offered virtual worship services were able to “continue operations comparable to its operation prior to the closure,” we would argue that such is not the case. Not only are virtual worship services not comparable to regular in-person worship meetings, but most churches stopped or limited other significant aspects of their operations, such as children’s ministries, Sunday schools, fellowship events, and more.

Similarly, even though schools may have continued conducting classes online, many other school functions were stopped or limited, including athletics and other extracurricular activities.

Until and unless additional official guidance to the contrary is published, our firm believes this position with respect to churches and schools is reasonable, assuming that the suspended operations are more than a nominal portion of the church or school’s business operations as defined in Notice 2021-20.

Church leaders should further consult with qualified local legal counsel to make the final determination as to whether their church was subject to a full or partial suspension of activities due to government orders.

Assuming the IRS agrees with the above interpretation, the ERC could represent a significant financial benefit to churches, schools, and other entities required to suspend or limit group meetings, particularly those with 100 or fewer full-time employees in 2019.

The reason: for such organizations, the credit is half of the first $10,000 in wages paid to all employees during the applicable period, regardless of whether such employees are providing services for the organization or not. That treatment contrasts dramatically with the treatment of organizations with more than 100 full-time employees in 2019. For those organizations, the credit is half of the first $10,000 in wages paid during the applicable period only to employees while they are not currently providing services to the organization.

Through Notice 2021-23, the IRS specifically addresses the ERC for the period January 1, 2021, through June 30, 2021, and amplifies guidance given in Notice 2021-20. Unless otherwise noted below, information included in Notice 2021-20 continues to apply to the ERC for January 1, 2021, through June 30, 2021.

The following material is designed to help church leaders understand the ERC for this time period.

For this time period, the ERC provides eligible employers—including tax-exempt organizations—a refundable credit against the employer’s share of Social Security tax (the 6.2 percent portion, not the 1.45 percent Medicare tax).

Eligible employers must have carried on a trade or business during 2021 and satisfy one of two economic hardship tests (again, for tax-exempt organizations described in Section 501(c) of the Internal Revenue Code, all operations of the organization are considered a trade or business for this purpose):

The credit is 70 percent of the first $10,000 in wages per employee (including the value of qualified health plan benefits) paid during each of the first two calendar quarters of 2021, during which the church qualifies.

Thus, the maximum credit per employee is $7,000 per quarter for the first two quarters of 2021 (for a total of $14,000).

The credit is reduced by any credits claimed for emergency sick pay or emergency family leave pay under the FFCRA or for other credits applicable to the same wages.

To the extent the credit exceeds the church’s Social Security tax due, the excess is considered a refundable overpayment.

For employers with an average of more than 500 full-time employees in 2019, only wages paid to employees for periods during which they were not currently providing services due to an economic hardship (either (1) a full or partial suspension of operations by order of a governmental authority due to COVID-19 or (2) a significant decline in gross receipts) are eligible for the credit.

For eligible employers with an average of 500 or fewer full-time employees in 2019, wages paid to all employees (regardless of whether they were providing services) during a period of economic hardship (as defined above) are eligible for the credit.

Some churches, schools, and charities may experience revenue declines in the first or second calendar quarter of 2021 in excess of 20 percent as compared to the same quarter of 2019 and may qualify for the credit accordingly.

Additionally, churches, schools, and other organizations that were subject to mandatory full or partial suspension of operations or group meetings (including mandatory government orders that required or resulted in capacity limitations in connection with such operations or group meetings, assuming the capacity limitations had more than a nominal effect on the operations) appear eligible for the ERC regardless of whether they were able to continue carrying on certain of their activities via remote participation. The same analysis discussed for the March 13, 2020, through December 31, 2020, time period above also applies here.

Again, the ERC could represent a significant financial benefit to churches, schools, and other entities required to suspend or limit group meetings, particularly those with 500 or fewer full-time employees in 2019.

The reason is that for such organizations, the credit is 70 percent of the first $10,000 in wages paid to all employees during the applicable quarter, regardless of whether such employees are providing services for the organization or not.

That treatment contrasts dramatically with the treatment of organizations with more than 500 full-time employees in 2019. For those organizations, the credit is 70 percent of the first $10,000 in wages paid during the applicable quarter only to employees while they are not currently providing services to the organization.

Through ARPA and the Infrastructure INvestment Act (enacted in November of 2021), the ERC for the third quarter of 2021 generally follows the same rules for the first and second quarter 2021, with specific changes noted below. The IRS released IRS Notice 2021-49 that provides additional guidance regarding the ERC for this time period.

Of note:

Nuances within the ERC eligibility rules and definitions described above create opportunities for organizations to be eligible for the ERC that may not be obvious to an organization without careful consideration of an organization’s particular facts. We have included some examples of “not-so-obvious” scenarios that may cause your church to be eligible for the ERC. This is not an exhaustive list of possibilities but is intended to demonstrate that the definitions and rules described in the guidance above must be carefully considered and evaluated.

The law and guidance surrounding the ERC are not abundantly clear with respect to whether affiliated nonprofit organizations are required or permitted to aggregate their activities and operations in determining eligibility for, or the amount of, an ERC claim. For example, assume that a church has the authority to control its separately incorporated foundation via the appointment of the foundation’s board members or that a church has such authority with respect to its separately incorporated school. In such cases, are the “parent” organizations required, or permitted, to aggregate their activities and operations with their “subsidiary” organizations for ERC purposes? The answer could make a huge difference in eligibility for, or the amount of, an ERC claim depending on the circumstances.

For example, assume that a church had 450 full-time employees in 2019 and that its subsidiary foundation had 70 employees in 2019. Aggregation would have a very negative effect on the potential amount of an ERC claim since the total 2019 full-time employee count is over 500 employees.

On the other hand, assume that a church and its subsidiary school had a total of 300 full-time employees in 2019 (200 in the church and 100 in the school). Assume further that the school (but not the church) had a partial suspension of its operations due to government orders during the first three quarters of 2021. Based on IRS guidance as we understand it, for the purposes of an ERC claim, the aggregation of the church and the school would mean that the church is deemed to have a partial suspension of operations due to government orders for the same period as the school. Aggregation would cause the church to be eligible for a very sizable ERC claim, even though it would not otherwise qualify on its own.

Since there is very little official guidance on the matter of aggregation of affiliated tax-exempt entities for ERC purposes, our firm works with our clients on a case-by-case basis in addressing this issue, together with special legal counsel. Thus far, legal counsel seems to be generally advising clients that aggregation is required in situations where one exempt organization controls another exempt organization—except in cases when one of the exempt organizations is a church. When one of the entities is a church, counsel generally seems to conclude that the church may elect to aggregate, but it is not required to do so.

Notwithstanding this commentary here about conclusions generally being reached by our clients’ legal counsel, it’s worth reiterating our strong recommendation that this issue should be addressed case-by-case and that special legal counsel should provide guidance to each affiliated group on the matter of aggregation, especially if the amounts of ERC that would be claimed would be significantly affected by the conclusion.

As noted at the beginning of the article, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 created a separate ERC for wages paid or incurred by nonprofit employers located in qualified disaster zones after the nonprofit employer’s business became inoperable because of damage from a 2020 qualified disaster.

Qualified disaster zones are specifically designated for each federally declared disaster. The qualified disaster ERC is equal to 40 percent of up to $6,000 of wages for each qualifying employee for the 2020 tax year. Wages for this purpose are generally FICA wages and do not include any wages claimed in applying for the COVID-19 relief ERCs described above.

Unlike the general COVID-19 relief ERC credit described above, the qualified disaster ERC is a non-refundable credit against the employer’s share of Social Security tax (the 6.2 percent portion, not the 1.45 percent Medicare tax).

Nonprofits may claim the credit by filing Form 5884-D. A list of 2020 federally declared disasters will be included in the Form 5884-D instructions (the COVID-19 pandemic is not included in the list of 2020 federally declared disasters for this purpose).

Kaylyn Varnum, CPA, is a partner and the assistant national director for tax services at Batts Morrison Wales & Lee (BMWL); Michele Wales, CPA, is a partner and the national director for tax services at BMWL; Michael (Mike) E. Batts, CPA, is the managing partner of BMWL. BMWL is an accounting firm dedicated exclusively to serving churches, ministries, and other nonprofit organizations across the United States.