Do Churches Qualify for the Employee Retention Credit?

The Employee Retention Credit (ERC) was established as a refundable tax credit to assist employers, including tax-exempt organizations, who retained employees during the COVID-19 pandemic. This incentive aimed to provide financial relief to those impacted by a significant decline in gross receipts or a full or partial suspension of operations due to governmental orders. Churches often navigate specific eligibility criteria and wage definitions for this credit.

General Eligibility for Tax-Exempt Organizations

Tax-exempt organizations, including churches, can qualify for the Employee Retention Credit through a significant decline in gross receipts or a full or partial suspension of operations due to a governmental order. An organization needs to meet only one of these criteria.

For the significant decline in gross receipts test, requirements differ between 2020 and 2021. In 2020, an organization qualified if its gross receipts for a calendar quarter were less than 50% of its gross receipts for the same calendar quarter in 2019. Eligibility continued until the quarter after the one in which gross receipts exceeded 80% of the gross receipts for the comparable 2019 quarter. For 2021, an organization qualified if its gross receipts for a calendar quarter were less than 80% of its gross receipts for the same calendar quarter in 2019.

Gross receipts for tax-exempt organizations encompass all income from various sources, without reduction for costs or expenses. This includes contributions, gifts, grants, gross sales from business activities, dues or assessments from members, and investment income such as rents, interest, dividends, and royalties. Proceeds from the sale of assets are also included in gross receipts, without reduction for the asset’s cost or sale expenses. Unrealized gains and losses are not included in this calculation.

Alternatively, an organization can qualify if its operations were fully or partially suspended due to a governmental order limiting commerce, travel, or group meetings because of COVID-19. This suspension must stem from an official governmental directive, not a voluntary decision by the organization. Examples relevant to churches include capacity limitations on in-person services, cancellation of events, or restrictions on gathering sizes. Even if a church was deemed an essential business, a governmental order limiting its capacity, such as to 50% of its worship facilities, could constitute a partial suspension.

Organizations that received Paycheck Protection Program (PPP) loans can still qualify for the ERC. However, wages used to obtain PPP loan forgiveness cannot also be used as qualified wages for the ERC. This prevents a double benefit from the same payroll costs.

Determining Qualified Wages for Churches

Qualified wages for the Employee Retention Credit include cash wages, tips, and the cost of employer-provided health plan expenses. For 2020, the maximum credit was 50% of qualified wages, up to $10,000 per employee for all qualifying quarters, resulting in a maximum credit of $5,000 per employee. For 2021, the credit increased to 70% of qualified wages, up to $10,000 per employee per quarter, allowing for a maximum credit of $7,000 per employee per quarter. These limits apply to wages paid from March 13, 2020, through September 30, 2021, for most employers.

The definition of qualified wages is influenced by the employer’s size, specifically the average number of full-time employees in 2019. For 2020, a “small” employer was defined as one with 100 or fewer full-time employees in 2019. For these small employers, all wages paid to employees during the eligible period qualified for the credit, regardless of whether the employees were actively providing services. For 2021, the definition of a “small” employer expanded to include those with 500 or fewer full-time employees in 2019. Similarly, for these employers, all wages paid to employees during the eligible period were considered qualified wages.

Conversely, “large” employers, defined as those with more than 100 full-time employees in 2019 for 2020, and more than 500 full-time employees in 2019 for 2021, have a more restrictive definition of qualified wages. For these employers, only wages paid to employees for time they were not providing services due to the suspension of operations or a significant decline in gross receipts could be counted. A full-time employee is generally defined as someone who worked an average of at least 30 hours per week or 130 hours in a month during 2019.

Special considerations apply to churches regarding certain compensation elements. Ministers’ housing allowances or parsonage, which are typically excluded from taxable income for ministers, generally do not qualify as wages for ERC purposes unless they are subject to FICA taxes. This is because qualified wages are typically based on taxable wages. However, sick leave wages paid under specific conditions, such as for COVID-19 quarantine, may qualify.

When a church is part of a larger organization, such as a denomination or has affiliated schools or daycare centers, aggregation rules may apply. Under these rules, all entities under common control are treated as a single employer for determining eligibility, employee counts, and gross receipts. This means that if one entity within the aggregated group qualifies, the entire group may qualify for the credit. The specific application of aggregation rules to tax-exempt entities, especially churches, can be complex and may require careful interpretation of IRS guidance.

Wages paid to certain family members of a majority owner are generally not considered qualified wages for the ERC. The IRS applies attribution rules to determine ownership, and if a majority owner has specific family relationships (e.g., child, sibling, ancestor, or lineal descendant), wages paid to that owner and their spouse are typically excluded. This exclusion aims to prevent a business owner from claiming the credit for wages paid to themselves or immediate family members who are considered to have a constructive ownership interest.

Claiming and Documenting the Credit

To claim the Employee Retention Credit, eligible employers typically file an amended payroll tax return, Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. This form is used to correct previously filed Form 941, Employer’s Quarterly Federal Tax Return. A separate Form 941-X must be filed for each calendar quarter for which the credit is being claimed.

When completing Form 941-X, the refundable portion of the ERC is entered on specific lines, such as line 26a. Qualified wages are reported on line 30, and qualified health plan expenses are reported on line 31a. The form requires the employer’s identification number, business name, and the specific quarter and year being corrected. The deadlines for amending returns are generally April 15, 2024, for 2020 claims and April 15, 2025, for 2021 claims.

Maintaining thorough and accurate records is essential to support an ERC claim and prepare for potential audits. The Internal Revenue Service (IRS) may audit ERC claims to verify accuracy and compliance with the CARES Act and subsequent legislation. Documentation should be retained for at least four years after filing the fourth quarter for the year the credit was claimed.

Key records to maintain include:

• Detailed payroll records showing qualified wages paid, including dates and amounts of payments, and employee information such as names and Social Security numbers.
• Documentation of governmental orders that led to a full or partial suspension of operations, along with evidence of the impact on the organization’s activities.
• Financial statements, bank records, and other documents supporting the gross receipts data for decline claims.
• Documentation showing the number of full-time employees in 2019 is also important for determining employer size.
• If a Paycheck Protection Program loan was received, records detailing the forgiveness amounts and the wages used for that forgiveness must be kept to avoid using the same wages for both programs.
• All calculations used to determine the credit amount should be retained.

The general statute of limitations for amending returns is typically three years from the date the original return was filed or two years from the date the tax was paid, whichever is later. However, recent legislation has extended the statute of limitations for ERC assessments to six years from the date the return was filed or the claim for credit was made.