Nonprofit Employee Retention Credit: ERC Eligibility, Calculation, and the IRS Moratorium

Tax-exempt organizations under IRC 501(c) were eligible for the Employee Retention Credit (ERC) on the same basis as for-profit employers. The credit was enacted under the CARES Act (March 2020) and expanded significantly by the Consolidated Appropriations Act (December 2020) and the American Rescue Plan Act (March 2021). For nonprofits, the ERC was particularly valuable because tax-exempt organizations do not pay income tax, which limits their access to most tax incentives. The ERC is a payroll tax credit, refundable against the employer’s share of Social Security tax (and refunded if the credit exceeds the tax), which means nonprofits receive the same dollar benefit as for-profit employers. Many nonprofits that qualified never claimed the credit because their payroll providers or CPAs did not identify the eligibility, and the IRS’s moratorium on new claims (announced September 2023) has complicated late filing.

How does the ERC eligibility test work for nonprofits?

A nonprofit is eligible for the ERC in a given calendar quarter if it meets either of two tests:

Test 1: Full or partial suspension of operations. The nonprofit’s operations were fully or partially suspended during the quarter due to a government order (federal, state, or local) related to COVID-19. A “partial suspension” means that more than a nominal portion of the organization’s operations were suspended. The IRS has interpreted “more than nominal” as meaning that the suspended operations account for more than 10% of either the organization’s revenue or the time the employees spent on the suspended function.

For nonprofits, the suspension test often applies when: the organization’s physical location was closed or restricted (a community center, church, museum, or food bank that could not admit the public during lockdown periods), in-person programming was cancelled or reduced (youth programs, counseling services, community events), or the organization’s mission-critical activities were restricted by government order (a performing arts organization that could not hold performances).

The suspension must be caused by a government order, not by the organization’s voluntary decision to close or reduce operations. A nonprofit that chose to close its office and move to remote work when no government order required it does not qualify under the suspension test. But a nonprofit that reduced in-person operations because a government order limited gathering sizes, required social distancing, or imposed capacity restrictions does qualify for a partial suspension.

Test 2: Significant decline in gross receipts. The nonprofit’s gross receipts for a calendar quarter declined significantly compared to the same quarter in 2019. For 2020, “significant decline” means a decline of more than 50%. For 2021, the threshold was reduced to more than 20%.

For nonprofits, “gross receipts” includes: contributions and grants, program service revenue, membership dues, investment income, and any other receipts. Government grants are included in gross receipts. For organizations that received large government grants specifically related to COVID-19 (CARES Act funding, PPP loans that were forgiven, state relief grants), those amounts are included in gross receipts for the quarter received, which can create a situation where a quarter that felt economically distressed actually shows an increase in gross receipts because of the relief funding.

The gross receipts test is applied quarter by quarter. A nonprofit might qualify in Q2 2020 (when contributions dropped) but not in Q4 2020 (when year-end giving recovered). Each quarter is evaluated independently.

How is the credit calculated?

2020 credit:

• Credit rate: 50% of qualified wages
• Wage cap: $10,000 per employee for the entire year
• Maximum credit: $5,000 per employee for the year
• Large employer threshold: 100+ full-time employees (monthly average in 2019)

2021 credit (Q1-Q3 only; Q4 was retroactively repealed for most employers):

• Credit rate: 70% of qualified wages
• Wage cap: $10,000 per employee per quarter
• Maximum credit: $7,000 per employee per quarter ($21,000 per employee for Q1-Q3)
• Large employer threshold: 500+ full-time employees (monthly average in 2019)

What are “qualified wages”? The definition depends on whether the employer is a “large” or “small” employer:

For small employers (under 100 FTEs in 2020, under 500 FTEs in 2021): qualified wages include all wages paid to all employees during the eligible quarter, regardless of whether the employees were working or not. This is the broader definition and benefits most nonprofits, which typically have fewer than 100 or 500 employees.

For large employers (100+ FTEs in 2020, 500+ FTEs in 2021): qualified wages include only wages paid to employees who were NOT providing services during the eligible quarter (employees who were furloughed or whose hours were significantly reduced). Wages paid to employees who continued working do not qualify.

Qualified wages include: gross wages, salary, tips, and the employer’s share of health plan costs allocable to qualified wages. The health plan cost component is often overlooked and can increase the credit by 20-30% for employers with generous health benefits.

Interaction with PPP. Wages used to support PPP loan forgiveness cannot also be used for the ERC. This was not the case under the original CARES Act (which prohibited ERC for PPP borrowers entirely), but the Consolidated Appropriations Act retroactively allowed ERC for PPP borrowers, provided they do not double-count the same wages. The organization must allocate wages between PPP and ERC to maximize the combined benefit, and the allocation should be done deliberately (not by default).

What is the IRS moratorium and how does it affect nonprofits?

In September 2023, the IRS announced a moratorium on processing new ERC claims (filed on Form 941-X). The moratorium was a response to widespread fraudulent and inflated claims promoted by “ERC mills” (companies that aggressively marketed the credit and charged contingency fees, often to employers who did not qualify).

Current status (as of 2025-2026): The IRS has been processing the backlog of existing claims slowly, with a significant denial rate. The IRS has also offered a Voluntary Disclosure Program for employers who received ERC payments they were not entitled to (allowing them to repay the credit at a reduced rate). The moratorium on new claims has been partially lifted for certain categories, but the IRS continues to scrutinize new filings heavily.

What this means for nonprofits that have not yet claimed:

1. Filing is still technically possible (the statute of limitations for 2020 claims is three years from the original filing date, which for most quarterly filers was April 2024; 2021 claims have until April 2025). However, the moratorium has created processing delays of 12-18 months or longer.
2. The IRS is applying heightened scrutiny to all new claims. Claims filed after the moratorium announcement are flagged for additional review.
3. Nonprofits that legitimately qualify should still file, but should do so with professional preparation (CPA review of the eligibility analysis, wage calculations, and PPP allocation) and thorough documentation of the government orders and operational impact.
4. Nonprofits should not use contingency-fee ERC promoters. The IRS has identified contingency-fee arrangements as a red flag, and many promoted claims have been denied or subjected to penalties.

What documentation should a nonprofit maintain?

The IRS has signaled that it will audit ERC claims aggressively. Nonprofits should maintain:

For the suspension test: Copies of the government orders (federal, state, local) that caused the full or partial suspension. A narrative description of how the order affected the organization’s specific operations (not a generic statement about COVID impact, but a specific description: “Our in-person youth mentoring program, which served 200 participants weekly, was suspended from March 15 through June 30, 2020, due to the Governor’s Executive Order No. 20-04 prohibiting gatherings of more than 10 people”). Documentation of the suspended operations’ share of total revenue or employee time (to support the “more than nominal” threshold).

For the gross receipts test: Quarterly gross receipts for 2019, 2020, and 2021, reconciled to the financial statements or Form 990. If the organization uses the cash method, gross receipts are cash received; if accrual, they are revenue earned.

For the wage calculation: Payroll registers for each eligible quarter showing gross wages by employee. Health plan cost allocation by employee (the employer’s share of premiums, not the employee’s contribution). Identification of which wages were used for PPP forgiveness (to avoid double-counting). For large employers, documentation of which employees were not providing services during the eligible quarters.

What should I do next?

If your nonprofit has not evaluated ERC eligibility, the evaluation should happen now, before the statute of limitations closes on remaining quarters. If you received an ERC payment and are uncertain about the eligibility, review the claim with a CPA (not the promoter who filed it). If you received a denial letter, evaluate whether the denial is correct or whether an appeal or refiling is warranted.

• Nonprofit Form 990 filing guide, the annual return where payroll and employment tax information is reported
• Church bookkeeping, the parallel ERC eligibility analysis for churches (which qualify under the same rules but face additional documentation challenges because of the church audit limitations under IRC 7611)
• Nonprofit governance, the board oversight that should review the ERC claim before filing
• Nonprofit UBIT, the separate tax obligation that exists alongside payroll tax credits
• IRS accuracy-related penalty, the penalty exposure if an ERC claim is denied and the organization has already spent the refund

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.