Employee Retention Credit Accounting Guidance for Nonprofits

The Employee Retention Credit (ERC) is one of a handful of federal programs aimed at helping organizations and businesses maintain healthy operations through the ongoing COVID-19 pandemic. For nonprofits, programs like the ERC and the Paycheck Protection Program (PPP) can be the difference between providing services and having to shutter their doors. But accounting for the ERC is a concern for many organizations. For example, how and when should ERC funds be recorded?

Brief Overview of the ERC in 2021

The ERC is a payroll tax credit awarded to organizations that meet specific criteria. In 2021, employers are eligible for the credit if:

1. Their operations have been fully or partially suspended due to government orders, or
2. They can prove at least a 20% decline in gross receipts.

Those that qualify will receive a credit against employment taxes for 70% of eligible wages paid to workers, at a maximum credit of $7,000 per employee per quarter. This credit will be refunded, or employers can apply to receive their credit in advance.

Which Accounting Guidance Should Nonprofits Use?

Since the ERC was introduced in March of 2020, nonprofits have wondered how to account for ERC funds properly. What accounting guidance governs these types of funds?

Because ERC funds are payroll tax credits, they cannot be accounted for as:

• Income taxes (under ASC Topic 740: Income Taxes)
• Loans or debt (under ASC Topic 470: Debt)

Since the ERC is a form of assistance from the federal government, one may be tempted to apply the model on government assistance, IAS 20: Accounting for Government Grants and Disclosure of Government Assistance. But IAS 20 does not apply to nonprofit organizations.

This leaves one remaining accounting guidance available to nonprofits: the revenue recognition standard under ASC Topic 958-605: Not-for-Profit Entities – Revenue Recognition – Contributions.

Applying ASC Topic 958-605 to the ERC

ASC Topic 958-605 dictates how (and when) nonprofits should record contributions they receive. Under this GAAP standard, an entity can only recognize funds when they meet (or substantially meet) the performance-related barriers to the contribution.

Before they can receive ERC funds, there are a handful of barriers nonprofits must overcome:

• Proving their gross receipts fell in 2021. In 2021, their gross receipts must be 80% or less than they were in (1) the comparable quarter from 2019 or (2) the immediately preceding quarter.

• Incurring eligible wages. This calculation will depend on whether the entity is considered a large or small employer. Large employers (those with more than 500 full-time employees in 2019) can only count their wages to stay home. Small employers can include the wages of all employees.

• Not double-counting their wages. The ERC wage calculation excludes wages that the organization uses to qualify for:

• PPP loan forgiveness
• The Work Opportunity Tax Credit (WOTC)
• The credit for paid family and medical leave under Section 45S
• The credit for paid sick and family leave under the Families First Coronavirus Response Act

The organization can utilize some or all these programs simultaneously, but they prove that they used different wages on each application.

Recognizing ERC Income

According to the revenue recognition standard under ASC Topic 958-605, the organization can recognize ERC income when they meet all program requirements and incur eligible wages. This means that some organizations can recognize ERC income before they even apply for the credit.

However, nonprofit leaders may choose to wait to recognize ERC income until their ERC application is approved. Typically, administrative requirements for grants or contributions are not a barrier to recognizing revenue, but management may take the position that the application process itself is a barrier. This more conservative approach is acceptable as long as the rationale is disclosed in the footnotes.

Once an organization meets all conditions to the contributions, they must know where to record that revenue. Even though the ERC is a payroll tax credit, the revenue should not directly reverse payroll tax expense on the financial statements; offsetting an organization’s payroll tax deposits is simply the mechanism by which the government chose to distribute the credit. Instead, ERC revenue should be recorded as a separate line item on the statement of activities, next to other contributions they receive.

Document Your Method, and Be Consistent

Your organization might interpret ASC Topic 958-605 slightly differently than other nonprofits, and that’s ok. From our perspective, it is highly important that nonprofit organizations do the following:

1. Use sound rationale when identifying the barriers your entity must overcome.
2. Document that rationale in the footnote disclosures.
3. Be consistent with the path you choose.

Contact Us

If you want to discuss how your nonprofit should record the ERC on your financial statements, or if you would like to learn more about how Klatzkin can help with another accounting or audit-related issue, click here to contact us. We look forward to speaking with you soon.

©2021 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date. The content is provided for informational purposes only and does not constitute accounting, tax, or financial advice. Please consult your advisor concerning your specific situation.