Outsourced Accounting

COVID-19 Financial Management Strategies and Financial Contingency Planning

Not-for-profit organizations are almost always dealing with the fragile nature of their operations and existence. Fears of possible loss of major donors, fears of recession, changes in tax laws, changes in reimbursement revenues, changes in government regulations, and dealing with the ever increasing cost of operations, are always present.

What are some financial steps your organization can take to weather this pandemic and survive?

  1. Assess Available Cash and Reserves
    1. Your organization should know where you are with available cash.
    2. Determine how much of this available cash is unrestricted by reviewing your operating, money market, investment accounts, board reserves and review all receivable expected to be collected.
    3. Determine a typical months cash expenditures and consider different scenarios.
    4. Determine # of days of cash available by dividing available cash by a typical month’s expenditures to determine how long you can survive with no other sources of revenue or cash.
    5. Cash Flow projections over the next several months are important to identify future cash flow issues before they occur.
    6. Consider other possible sources of cash to include line-of credit, credit cards, board designated endowment funds, or donor restricted funds that would allow you to release restrictions for operating purposes.
    7. With this essential financial information, your board, management, and staff can work collectively to assess the urgency of the situation, make informed decisions, and develop a plan of action.
  2. Assess Impact on Organization’s Sources of Revenue
    1. Review sources of revenues and determine how they may change in the short term.   Keep in mind program service revenues may decrease significantly if the availability of these services decline.  Social service revenues may actually increase for services provided to vulnerable populations and fees for services contracts with federal, state, or local agencies may continue.  Grant making agencies and foundations may actually provide increased funding for short-term emergency needs
    2. Organizations who rely on investment earnings to fund operations should consult with investment advisors to determine projected investment revenues.
    3. Organization needs to prioritize those programs and activities with the most impact and profitability while considering reducing, delaying, or eliminating those programs and activities with less impact and profitability.  Can we reassign certain staff to those activities with greatest need and associated funding?  What is the financial impact if fundraising events need to be cancelled or rescheduled?
    4. Reach out to your supportive donors and foundations to explain to them your specific situation and what you are doing to address this crisis and your proposed solutions.  Also, ask them for support and help during the crisis.  You might suggest to donors to consider making their annual contributions now when its most needed instead of waiting until the end of the year.  For donors with restricted contributions, you might ask them if you can use their donation for general operations.    You should communicate your plan of action with progress updates so your donors can track  your progress and needs.  You might consider in-kind donations in addition to cash donations for goods, services, and volunteers.
  3. Assess Impact on Organization’s Expenditures
    1. You can identify variable expenditures(payroll, travel, and office expenses) and determine to what extent they can be reduced while still allowing you to operate
    2. You can reduce those program expenses where you experience reductions in program revenues
    3. You can increase program expenses from those programs that see increases and reallocate staff and resources from other program areas.
    4. You should evaluate each type of expense to determine the projected increases or decreases to the projected budget.
    5. This maybe the time when difficult decisions need to be made regarding the reduction or elimination of programs and activities including the reduction of employees.  Would some employees consider some volunteer services in order to keep the programs going and increase their chance of returning to work in the future?  Keep employees informed of upcoming potential lay-offs or terminations.
    6. You should contact vendors and negotiate extended payment terms or payment plans.  Also, contact your landlord or banker to delay rent or loan payments.  You might check to see if you bank would consider interest only payments instead of full payments for a short period of time.

It is important to communicate with everyone in the organization to find solutions and have a collaborative approach.  Lower level staff may have a better hands-on evaluation of what specific measures need to be taken.  This crisis in not a result of lack of oversight, poor management, or bad decision making.  Everyone seems to be effected by this crisis so take comfort in knowing that we are all going through this together at the same time.    Your organization can do it’s best by having a pro-active crisis response that’s decisive and provides timely and accurate communication to all.   You should be exploring all funding sources available to your organization including the federal loan, grant, and tax credit program available to help with these short-term financial needs.  You should take this opportunity to reach out and show everyone how you have taken control or your organization’s destiny.

There are 5 Nonprofit Finance Must-Do’s in the time of COVID.

  • Understand your cash position
  • Assess damage to revenue streams
  • Look at the dual bottom line to include financial and impact
  • Include everyone in the discussion
  • Communicate consistently

The following financial management strategies should be considered as financial contingency planning for your short-term financial needs with the following practical takeaways.

  1. Forgivable loans to maintain full operations.  You should pursue this option if you plan to continue at the same staffing level as you did before the crisis.  You will apply with your financial institution and it will pay your entire payroll for 8 weeks after funds are revised and pay your essential operating costs like rent payments, mortgage interest, and utilities.  We would suggest you track how these loan proceeds are used so you can maximize the loan forgiveness once these funds are spent.  Keep in mind the employer portion of Social Security and Medicare is excluded from the allowable payroll costs.
  2. Employer Social Security Tax Deferrals.  Employers can defer the deposit and payment of Social Security taxes from March 27, 2020 to December 31, 2020.  The deposit due date for 50% of the taxes is deferred to December 31, 2021 and the remaining 50% deferred until December 31, 2022.  Please note that an employer is ineligible to defer paying the Social Security Tax if it acquires a loan through the Paycheck Protection Program and receives a decision from the lender that the loan was forgiven.
  3. Families First Coronavirus Response Act – Employment Provisions.  Two weeks of emergency paid sick leave to quarantine, seek diagnosis, or preventive care including 2/3 regular rate for family member care.   Twelve weeks of emergency family and medical leave for those employers with more than 50 employees.  Employers paying the mandated paid leave are entitled to claim a refundable tax credit.
  4. Employee Retention Credit.  This is a fully refundable tax credit for employers equal to 50% of qualified wages from March 12, 2020 to December 31, 2020.  This is a great option for those organizations that have experienced a significant decrease in revenues or reduction in operations.   An eligible employer may not receive the employee retention credit if the eligible employer receives a paycheck protection loan.

You can use these financial contingency planning options, but feel free to customize what works best for your organization.  Let us know if we can provide assistance to help you make and implement these difficult financial decisions.

AICPA makes PPP loan forgiveness recommendations

The AICPA on Wednesday issued a series of recommendations it would like to see the U.S. Small Business Administration (SBA) adopt and issue as guidance for small businesses to use in calculating loan forgiveness under the Paycheck Protection Program (PPP).

In the release, the AICPA urges that:

  • The eight-week covered period under PPP should align with the beginning of a pay period, not the date loan proceeds are received.
  • The eight-week period should be flexible, with businesses able to choose to commence it once stay-at-home restrictions are lifted instead of when loan proceeds are received.
  • Full-time equivalents (FTEs) should be calculated using a simple wage-based proxy when hours worked are not tracked by the employer (e.g., for salaried workers or those paid by piece).
  • Payroll reduction calculations should be based on an employee’s average payroll per week in the eight-week period compared to the prior quarter, rather than comparing total compensation in the periods. Loan forgiveness is reduced if an employee’s compensation decreases by more than 25% but an eight-week period will naturally have 33% less payroll than a 12-week quarter.

The AICPA also addressed the eight-week loan forgiveness period in a letter sent late Tuesday to Treasury Secretary Steven Mnuchin and SBA Administrator Jovita Carranza. In the letter, signed by AICPA President and CEO Barry Melancon, CPA, CGMA, the AICPA lays out the case for changing the current interpretation for when to start the eight-week period for the forgiveness calculation component of the program.

Congress created the PPP as part of the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. The legislation authorized Treasury to use the SBA’s 7(a) small business lending program to fund loans of up to $10 million per borrower that qualifying businesses could spend to cover payroll, mortgage interest, rent, and utilities. PPP borrowers can qualify to have the loans forgiven if the proceeds are used to pay certain eligible costs. However, the amount of loan forgiveness will be reduced if less than 75% of the funds are spent on payroll over an eight-week loan forgiveness period.

Current guidance from Treasury and the SBA interprets the eight-week period as beginning on the date the lender makes the disbursement of the PPP loan to the borrower. However, the AICPA says, with many states still shut down by government order, most small businesses are unable to bring their employees back to work. For those businesses, starting the loan forgiveness clock on the date the lender disburses the funds means the recipient business must either pay employees while it is unable to operate or forgo the maximum amount of loan forgiveness. Flexibility in the start dates of the eight-week period would position more small businesses to survive and contribute to an economic rebound while working within the parameters of the CARES Act and subsequent guidance.

To address this problem, the AICPA letter urges Treasury to “[i]mmediately take a very simple but critical step and define the origination date as the date on which a state’s shelter-in-place order is lifted and businesses are authorized by government to return to full operations. This will provide the necessary flexibility for the 8-week clock to start, businesses to bring back employees and to pay sufficient payroll to meet the 75% requirement.”

Recommendations provided

The AICPA has received numerous questions from CPAs about the loan forgiveness portion of the PPP. Many of those inquiries have sought answers on the documents and calculations that should be used in applying for loan forgiveness to be awarded.

In response, the AICPA has developed recommendations for applying for loan forgiveness that have been added to earlier recommendations on how to apply for PPP loans. The full list of recommendations is available on the AICPA’s website.

The AICPA said in the release that it has requested further clarification on how reductions in forgiveness are to be applied. Specifically, the AICPA is seeking clarity regarding how reductions in forgiveness are to be applied and whether the CARES Act lists forgiveness reductions in the intended order of application, as some of the forgiveness requirements cause a dollar reduction while others produce a percentage reduction. The order in which these are applied can have a significant impact on the forgiveness amount.

The AICPA’s recommendations were made in consultation with an AICPA-led small business funding coalition, CPA firms, and other key stakeholders. They build on previous guidelines the AICPA has provided to help bring clarity to the implementation of the PPP.

The PPP so far

Congress established the PPP through the CARES Act, which was signed into law on March 27. The program is available to small businesses that were in operation on Feb. 15 with 500 or fewer employees, including not-for-profits, veterans’ organizations, tribal concerns, self-employed individuals, sole proprietorships, and independent contractors. Businesses with more than 500 employees in certain industries also can apply for loans, according to the SBA and Treasury.

SBA lenders were flooded with PPP applications from businesses in need of resources to help their businesses as the coronavirus pandemic and the consequences from social-distancing requirements devastated the economy. By April 16, the SBA had stopped accepting applications for the PPP after exhausting the initial $349 billion in funding. Last week, Congress approved an additional $370 billion in funding for small businesses, with $310 billion in fresh funds provided to the PPP. The application window for the second round of PPP funding opened Monday.

The AICPA’s Paycheck Protection Program Resources page houses resources and tools produced by the AICPA to help address the economic impact of the coronavirus.

For more news and reporting on the coronavirus and how CPAs can handle challenges related to the pandemic, visit the JofA’s coronavirus resources page.

 Jeff Drew (Jeff.Drew@aicpa-cima.com) is a JofA senior editor.

Employer Social Security Tax Deferrals

The Coronavirus, Aid, Relief and Economic Security Act (CARES Act) allows employers to defer the deposit and payment of the employer’s share of Social Security taxes and self-employed individuals to defer payment of certain self-employment taxes.

Employers pay Social Security taxes at a rate of 6.2% on the first $137,700 of wages paid to employees for calendar year 2020. The CARES Act allows all employers to defer payment of employer Social Security taxes that are otherwise owed for wage payments made after March 27, 2020, through the end of the calendar year. Instead of depositing these taxes on a next-day or semi-weekly basis, the deposit due date for 50% of the taxes is deferred to December 31, 2021, with the remaining 50% deferred until December 31, 2022.

All employers should work with their payroll provider, payroll departments or payroll software to immediately begin deferring these employer Social Security taxes. The only possible exception is employers that are applying for the Small Business Administration (SBA) loans under the CARES Act. Even these employers are eligible for the deferrals until they receive loan forgiveness.

Section 2302 of the CARES Act does not apply to the employee’s share of Social Security tax, the employee or employer’s share of Medicare tax, or to the Additional Medicare tax imposed on employees with Medicare wages in excess of 200K. In addition, filing deadlines for reporting the employee and employer portions of Social Security and Medicare taxes have not been delayed by the Act.

Please note, an employer is ineligible to defer paying its portion of Social Security tax if it acquires a loan through the Paycheck Protection Program, established by section 1102 of the CARES Act, for which all or part of the loan was or will be forgiven.

These FAQs address specific issues related to the deferral of deposit and payment of these employment taxes. These FAQs will be updated to address additional questions as they arise.

1. What deposits and payments of employment taxes are employers entitled to defer?

Section 2302 of the CARES Act provides that employers may defer the deposit and payment of the employer’s portion of Social Security taxes and certain railroad retirement taxes. These are the taxes imposed under section 3111(a) of the Internal Revenue Code (the “Code”) and, for Railroad employers, so much of the taxes imposed under section 3221(a) of the Code as are attributable to the rate in effect under section 3111(a) of the Code (collectively referred to as the “employer’s share of Social Security tax”). Employers that received a Paycheck Protection Program loan may not defer the deposit and payment of the employer’s share of Social Security tax that is otherwise due after the employer receives a decision from the lender that the loan was forgiven. (See FAQ 4).

2. When can employers begin deferring deposit and payment of the employer’s share of Social Security tax without incurring failure to deposit and failure to pay penalties?

The deferral applies to deposits and payments of the employer’s share of Social Security tax that would otherwise be required to be made during the period beginning on March 27, 2020, and ending December 31, 2020. (Section 2302 of the CARES Act calls this period the “payroll tax deferral period.”)

The Form 941, Employer’s QUARTERLY Federal Tax Return, will be revised for the second calendar quarter of 2020 (April – June, 2020). Information will be provided in the near future to instruct employers how to reflect the deferred deposits and payments otherwise due on or after March 27, 2020 for the first quarter of 2020 (January – March 2020).  In no case will Employers be required to make a special election to be able to defer deposits and payments of these employment taxes.

3. Which employers may defer deposit and payment of the employer’s share of Social Security tax without incurring failure to deposit and failure to pay penalties?

All employers may defer the deposit and payment of the employer’s share of Social Security tax. However, employers that receive a loan under the Small Business Administration Act, as provided in section 1102 of the CARES Act (the Paycheck Protection Program (PPP)), may not defer the deposit and payment of the employer’s share of Social Security tax due after the employer receives a decision from the lender that the PPP loan is forgiven under the CARES Act.  See FAQ 4.

4. Can an employer that has applied for and received a PPP loan that is not yet forgiven defer deposit and payment of the employer’s share of Social Security tax without incurring failure to deposit and failure to pay penalties?

Yes. Employers who have received a PPP loan may defer deposit and payment of the employer’s share of Social Security tax that otherwise would be required to be made beginning on March 27, 2020, through the date the lender issues a decision to forgive the loan in accordance with paragraph (g) of section 1106 of the CARES Act, without incurring failure to deposit and failure to pay penalties. Once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer deposit and payment of the employer’s share of Social Security tax due after that date. However, the amount of the deposit and payment of the employer’s share of Social Security tax that was deferred through the date that the PPP loan is forgiven continues to be deferred and will be due on the “applicable dates,” as described in FAQs 7 and 8.

5. Is this ability to defer deposits of the employer’s share of Social Security tax in addition to the relief provided in Notice 2020-22 for deposit of employment taxes in anticipation of the Families First Coronavirus Relief Act (FFCRA) paid leave credits and the CARES Act employee retention credit?

Yes. Notice 2020-22 provides relief from the failure to deposit penalty under section 6656 of the Code for not making deposits of employment taxes, including taxes withheld from employees, in anticipation of the FFCRA paid leave credits and the CARES Act employee retention credit. The ability to defer deposit and payment of the employer’s share of Social Security tax under section 2302 of the CARES Act applies to all employers, not just employers entitled to paid leave credits and employee retention credits. (But see the limit described in FAQ 4 for employers that have a PPP loan forgiven.)

6. Can an employer that is eligible to claim refundable paid leave tax credits or the employee retention credit defer its deposit and payment of the employer’s share of Social Security tax prior to determining the amount of employment tax deposits that it may retain in anticipation of these credits, the amount of any advance payments of these credits, or the amount of any refunds with respect to these credits?

Yes. An employer is entitled to defer deposit and payment of the employer’s share of Social Security tax prior to determining whether the employer is entitled to the paid leave credits under sections 7001 or 7003 of FFCRA or the employee retention credit under section 2301 of the CARES Act, and prior to determining the amount of employment tax deposits that it may retain in anticipation of these credits, the amount of any advance payments of these credits, or the amount of any refunds with respect to these credits.

7. What are the applicable dates by which deferred deposits of the employer’s share of Social Security tax must be deposited to be treated as timely (and avoid a failure to deposit penalty)?

The deferred deposits of the employer’s share of Social Security tax must be deposited by the following dates (referred to as the “applicable dates”) to be treated as timely (and avoid a failure to deposit penalty):

  1. On December 31, 2021, 50 percent of the deferred amount; and
  2. On December 31, 2022, the remaining amount.

8. What are the applicable dates when deferred payment of the employer’s share of Social Security tax must be paid (to avoid a failure to pay penalty under section 6651 of the Code)?

The deferred payment of the employer’s share of Social Security tax is due on the “applicable dates” as described in FAQ 7.

9. Are self-employed individuals eligible to defer payment of self-employment tax on net earnings from self-employment income?

Yes. Self-employed individuals may defer the payment of 50 percent of the Social Security tax on net earnings from self-employment income imposed under section 1401(a) of the Code for the period beginning on March 27, 2020, and ending December 31, 2020. (Section 2302 of the CARES Act calls this period the “payroll tax deferral period.”)

10. Is there a penalty for failure to make estimated tax payments for 50 percent of Social Security tax on net earnings from self-employment income during the payroll tax deferral period?

No. For any taxable year that includes any part of the payroll tax deferral period, 50 percent of the Social Security tax imposed on net earnings from self-employment income during that payroll tax deferral period is not used to calculate the installments of estimated tax due under section 6654 of the Code.

11. What are the applicable dates when deferred payment amounts of 50 percent of the Social Security tax imposed on self-employment income must be paid?

The deferred payment amounts are due on the “applicable dates” as described in FAQ 7.

 

What the Families First Coronavirus Response Act Means to Nonprofits

On March 19, the President signed into law, H.R. 6201, the Families First Coronavirus Response Act. The bill includes a complex set of temporary paid leave mandates and employer reimbursement provisions, as well as funding for free coronavirus testing, food nutrition security, and Unemployment extension.

Employment Provisions

The Families First Coronavirus Response Act imposes new job protections for workers, paid leave mandates on employers, and a generous reimbursement scheme for employers that are designed to hold nonprofit and for-profit employers. The law provides two weeks of paid sick leave, a subsequent ten weeks of partially paid family leave for care of a child, and refundable tax credits in many cases will result in the Treasury Department writing checks to employers to cover some of the costs of the mandates.

Two Weeks of Emergency Paid Sick Leave: The law (Section 5102) requires employers with fewer than 500 employees (including nonprofits) and government employers to provide their employees two weeks of paid sick leave, paid at the employee’s regular rate up to $511 per day, to quarantine or seek a diagnosis or preventive care for the coronavirus. It also requires payment at two-thirds the employee’s regular rate up to $200 per day to care for a family member for those purposes or to care for a child whose school has closed or child care provider is unavailable due to the coronavirus. These provisions expire at the end of December 2020.

The Secretary of Labor is authorized to exclude health care providers and emergency responders from the definition of employees allowed to take leave, exempt small businesses, including nonprofits, with fewer than 50 employees, and ensure consistency between paid family and paid sick standards and tax credits. In general, employees are entitled to 80 hours of paid sick time, and are immediately eligible for the leave under this bill.

Twelve Weeks of Emergency Family and Medical Leave: The law (Section 3102) expands the number of workers who can take up to 12 weeks of job-protected leave under the Family and Medical Leave Act for coronavirus-related reasons. After the two weeks of emergency paid leave (above), employees of employers with fewer than 500 employees will be eligible to receive at least two-thirds of each employee’s usual pay, up to $200 per day.  Employees must have been employed for at least 30 days to qualify and meet a “qualifying need related to a public health emergency.” The qualifying reasons for the emergency paid leave are caring for a child if the child’s school or childcare center is closed due to coronavirus. The provisions would also expire at the end of 2020.

Generally, employees taking Emergency FMLA have job protection, but the bill provides an exception for employers with fewer than 25 employees if the position no longer exists following leave due to operation changes from the public health emergency. Health care providers and emergency responders are also excluded from the definition of employees allowed to take this leave, and the law exempts small businesses, including nonprofits, with fewer than 50 employees.

Reimbursable Payroll Tax Credits Available: Employers paying for the mandated paid leave are entitled to claim a refundable tax credit. Specifically, the tax credit is allowed against the employer portion of payroll taxes, and any paid leave costs that exceed the amount of payroll taxes owed will be refundable to the employer at the end of each quarter. This means the federal government will cover all or a portion of the costs of these paid leave mandates. The amounts depend upon what the employee is doing.

Under the Paid Sick Leave Mandate: Employers paying for employees who must self-isolate, obtain a diagnosis, or comply with self-isolation recommendation with respect to coronavirus may receive tax credits of up to $511 per day. Payments to employees caring for a family member or for a child whose school or child care center is closed, qualified sick leave wages are capped at $200 per day. Both types of wages are capped at 10 days in the aggregate. (Section 7001)
Paid Family and Medical Leave Mandate: The refundable tax credit for qualified family leave provision is capped at $200 per day and $10,000 each quarter. (Section 7003)

FAQs: Employee Retention Credit under the CARES Act

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted on March 27, 2020, is designed to encourage Eligible Employers to keep employees on their payroll, despite experiencing economic hardship related to COVID-19, with an employee retention tax credit (Employee Retention Credit).

The Families First Coronavirus Relief Act (FFCRA) requires certain employers to pay sick or family leave wages to employees who are unable to work or telework due to certain circumstances related to COVID-19. Employers are entitled to a refundable tax credit for the required leave paid, up to specified limits. [See FAQs]. The same wages cannot be counted for both credits.

Basic FAQs

The Employee Retention Credit is a fully refundable tax credit for employers equal to 50 percent of qualified wages (including allocable qualified health plan expenses) that Eligible Employers pay their employees. This Employee Retention Credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000, so that the maximum credit for an Eligible Employer for qualified wages paid to any employee is $5,000.

Eligible Employers for the purposes of the Employee Retention Credit are those that carry on a trade or business during calendar year 2020, including a tax-exempt organization, that either:

  • Fully or partially suspends operation 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; or
  • Experiences a significant decline in gross receipts during the calendar quarter.

Generally, tax-exempt organizations that are consider essential would not qualify under the fully or partially suspends its operations criteria, but they could still could qualify with the significant decline in gross receipts criteria.

Note: Governmental employers are not Eligible Employers for the Employee Retention Credit.  Also, Self-employed individuals are not eligible for this credit for their self-employment services or earnings.

The operation of a trade or business may be partially suspended if an appropriate governmental authority imposes restrictions upon the business operations by limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 such that the operation can still continue to operate but not at its normal capacity.

Example: A state governor issues an executive order closing all restaurants, bars, and similar establishments in the state in order to reduce the spread of COVID-19. However, the executive order allows those establishments to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis. This results in a partial suspension of the operations of the trade or business due to an order of an appropriate governmental authority with respect to any restaurants, bars, and similar establishments in the state that provided full sit-down service, a dining room, or other on-site eating facilities for customers prior to the executive order.

A significant decline in gross receipts begins with the first quarter in which an employer’s gross receipts for a calendar quarter in 2020 are less than 50 percent of its gross receipts for the same calendar quarter in 2019.  The significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter for which the employer’s 2020 gross receipts for the quarter are greater than 80 percent of its gross receipts for the same calendar quarter during 2019.

Example: An employer’s gross receipts were $100,000, $190,000, and $230,000 in the first, second, and third calendar quarters of 2020, respectively.  Its gross receipts were $210,000, $230,000, and $250,000 in the first, second, and third calendar quarters of 2019, respectively.  Thus, the employer’s 2020 first, second, and third quarter gross receipts were approximately 48%, 83%, and 92% of its 2019 first, second, and third quarter gross receipts, respectively.  Accordingly, the employer had a significant decline in gross receipts commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50% of the same quarter in 2019) and ending on the first day of the third calendar quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80% of the same quarter in 2019). Thus the employer is entitled to a retention credit with respect to the first and second calendar quarters.

The credit equals 50 percent of the qualified wages (including qualified health plan expenses) that an Eligible Employer pays in a calendar quarter.  The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000, so that the maximum credit for qualified wages paid to any employee is $5,000.

Example 1: Eligible Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to the Eligible Employer for the qualified wages paid to Employee A is $5,000.

Example 2: Eligible Employer pays Employee B $8,000 in qualified wages in Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to the Eligible Employer for the qualified wages paid to Employee B is equal to $4,000 in Q2 and $1,000 in Q3 due to the overall limit of $10,000 on qualified wages per employee for all calendar quarters.

Qualified wages are wages (as defined in section 3121(a) of the Internal Revenue Code (the “Code”)) and compensation (as defined in section 3231(e) of the Code) paid by an Eligible Employer to employees after March 12, 2020, and before January 1, 2021. Qualified wages include the Eligible Employer’s qualified health plan expenses that are properly allocable to the wages.

The definition of qualified wages depends, in part, on the average number of full-time employees (as defined in section 4980H of the Code) employed by the Eligible Employer during 2019.

If the Eligible Employer averaged more than 100 full-time employees in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services due to 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.  For these employers, qualified wages taken into account for an employee may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.

If the Eligible Employer averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during any period of economic hardship described in (1) and (2) above.

No. The CARES Act does not require employers to pay qualified wages.  In addition, Eligible Employers may elect to not claim the credit for the Employee Retention Credit.  (The FFCRA does require certain employers to pay sick or family leave wages to employees who are unable to work or telework due to a COVID-19 circumstance.  These employers may be entitled to a refundable tax credit for those wages paid, although the employers may elect not to claim the credit.)

Eligible Employers may claim the Employee Retention Credit for qualified wages that they pay after March 12, 2020, and before January 1, 2021. Therefore, an Eligible Employer may be able to claim the credit for qualified wages paid as early as March 13, 2020.

No.  The Employee Retention Credit is only available with respect to wages paid after March 12, 2020, and before January 1, 2021.

The credit is allowed against the employer portion of social security taxes under section 3111(a) of the Internal Revenue Code (the “Code”), and the portion of taxes imposed on railroad employers under section 3221(a) of the Railroad Retirement Tax Act (RRTA) that corresponds to the social security taxes under section 3111(a) of the Code.

The credits are fully refundable because the Eligible Employer may get a refund if the amount of the credit is more than certain federal employment taxes the Eligible Employer owes.  That is, if for any calendar quarter the amount of the credit the Eligible Employer is entitled to exceeds the employer portion of the social security tax on all wages (or on all compensation for employers subject to RRTA) paid to all employees, then the excess is treated as an overpayment and refunded to the employer under sections 6402(a) and 6413(a) of the Code.  Consistent with its treatment as an overpayment, the excess will be applied to offset any remaining tax liability on the employment tax return and the amount of any remaining excess will be reflected as an overpayment on the return.  Like other overpayments of federal taxes, the overpayment will be subject to offset under section 6402(a) of the Code prior to being refunded to the employer.

Example: Eligible Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to the Eligible Employer for the qualified wages paid to Employee A is $5,000. This amount may be applied against the employer share of social security taxes that the Eligible Employer is liable for with respect to all employee wages paid in Q2 2020.  Any excess over the employer’s share of social security taxes is treated as an overpayment and refunded to the Eligible Employer after offsetting other tax liabilities on the employment tax return and subject to any other offsets under section 6402(a) of the Code.

Eligible Employers will report their total qualified wages and the related credits for each calendar quarter on their federal employment tax returns, usually Form 941, Employer’s Quarterly Federal Tax Return.  Form 941 is used to report income and social security and Medicare taxes withheld by the employer from employee wages, as well as the employer’s portion of social security and Medicare tax. 

In anticipation of receiving the credits, Eligible Employers can fund qualified wages by accessing federal employment taxes, including withheld taxes, that are required to be deposited with the IRS or by requesting an advance of the credit from the IRS.

Yes. An Eligible Employer may fund the qualified wages by accessing federal employment taxes, including those that the Eligible Employer already withheld, that are set aside for deposit with the IRS, for other wage payments made during the same quarter as the qualified wages.

That is, an Eligible Employer that pays qualified wages to its employees in a calendar quarter before it is required to deposit federal employment taxes with the IRS for that quarter may reduce the amount of federal employment taxes it deposits for that quarter by half of the amount of the qualified wages paid in that calendar quarter.  The Eligible Employer must account for the reduction in deposits on the Form 941, Employer’s Quarterly Federal Tax Return, for the quarter.

Example:  An Eligible Employer paid $10,000 in qualified wages (including qualified health plan expenses) and is therefore entitled to a $5,000 credit, and is otherwise required to deposit $8,000 in federal employment taxes, including taxes withheld from all of its employees, for wage payments made during the same quarter as the $10,000 in qualified wages.  The Eligible Employer has no paid sick or family leave credits under the FFCRA.  The Eligible Employer may keep up to $5,000 of the $8,000 of taxes the Eligible Employer was going to deposit, and it will not owe a penalty for keeping the $5,000.  The Eligible Employer is required to deposit only the remaining $3,000 on its required deposit date. The Eligible Employer will later account for the $5,000 it retained when it files Form 941, Employer’s Quarterly Federal Tax Return, for the quarter.

Yes.  An Eligible Employer will not be subject to a penalty under section 6656 of the Code for failing to deposit federal employment taxes relating to qualified wages in a calendar quarter if:

  1. the Eligible Employer paid qualified wages to its employees in the calendar quarter before the required deposit,
  2. the amount of federal employment taxes that the Eligible Employer does not timely deposit, reduced by any amount of federal employment taxes not deposited in anticipation of the paid sick or family leave credits claimed under the FFCRA, is less than or equal to the amount of the Eligible Employer’s anticipated Employee Retention Credit for the qualified wages for the calendar quarter as of the time of the required deposit, and
  3. the Eligible Employer did not seek payment of an advance credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, with respect to any portion of the anticipated credits it relied upon to reduce its deposits. 

For more information, about the relief from the penalty for failure to deposit federal employment taxes on account of qualified wages, see Notice 2020-22 (PDF).

Yes.  Because quarterly returns are not filed until after qualified wages are paid, some Eligible Employers may not have sufficient federal employment taxes set aside for deposit to the IRS to fund their qualified wages.  Accordingly, the IRS has established a procedure for obtaining an advance of the refundable credits.  

The Eligible Employer should first reduce its remaining federal employment tax deposits for wages paid in the same calendar quarter by the maximum allowable amount.  If the anticipated credit for the qualified wages exceeds the remaining federal employment tax deposits for that quarter, the Eligible Employer can file a Form 7200, Advance Payment of Employer Credits Due to COVID-19, to claim an advance refund for the full amount of the anticipated credit for which it did not have sufficient federal employment tax deposits.

If an Eligible Employer fully reduces its required deposits of federal employment taxes otherwise due on wages paid in the same calendar quarter to its employees in anticipation of receiving the credits, and it has not paid qualified wages in excess of this amount, it should not file the Form 7200.  If it files the Form 7200, it will need to reconcile this advance credit and its deposits with the qualified wages on Form 941 (or other applicable federal employment tax return such as Form 944 or Form CT-1), and it may have an underpayment of federal employment taxes for the quarter.

Example: An Eligible Employer paid $20,000 in qualified wages, and is therefore entitled to a credit of $10,000, and is otherwise required to deposit $8,000 in federal employment taxes, including taxes withheld from all of its employees, on wage payments made during the same calendar quarter.  The Eligible Employer has no paid sick or family leave credits under the FFCRA.  The Eligible Employer can keep the entire $8,000 of taxes that the Eligible Employer was otherwise required to deposit without penalties as a portion of the credits it is otherwise entitled to claim on the Form 941.  The Eligible Employer may file a request for an advance credit for the remaining $2,000 by completing Form 7200.

Yes, but not for the same wages.  The amount of qualified wages for which an Eligible Employer may claim the Employee Retention Credit does not include the amount of qualified sick and family leave wages for which the employer received tax credits under the FFCRA.  

No.  An Eligible Employer may not receive the Employee Retention Credit if the Eligible Employer receives a Small Business Interruption Loan under the Paycheck Protection Program that is authorized under the CARES Act (“Paycheck Protection Loan”). An Eligible Employer that receives a paycheck protection loan should not claim Employee Retention Credits.

NonProfits Guide to Fraud Prevention

Nonprofit organizations can be more susceptible to fraud due to having fewer resources available to help prevent and recover from fraud loss.  This sector is particularly vulnerable because of less oversight and lack of certain internal controls.  Nonprofit organizations have fewer anti-fraud controls in place, leaving them more vulnerable to fraud.  The top 3 control weaknesses from the ACFE 2020 RTTN include 35% lack of internal controls, 19% lack of management review, and 14% override of existing internal controls.   They are typically a lot less likely to an internal audit or surprise audit.

According to the most recent Fraud study conducted by the Association of Certified Fraud Examiners (ACFE), nonprofits account for 9% of all frauds and reported a median loss of $75,000 (ACFE 2020 RTTN) along with an even greater potential cost for reputational damage.  It maybe surprising, but the external audit is only likely to detect fraud 4% of the time.  The top detection methods include tips-40%; internal audit-17%; management review-13%; accident-7%; account reconciliation-5%; and document examination-6%.  With lack of board and management involvement in finance for nonprofits, it seems like we are relying too heavily tips and accidents to detect fraud.

6 FRAUD RISKS SPECIFIC TO NON-PROFITS
We’ve all heard the myths when it comes to fraud in not-for-profit organizations: “It can’t happen here. All of our volunteers and staff members are honest and committed to our mission, and besides they’ve been with us for years. If someone was stealing from us, we would have found it by now.” But the fact is that not-for-profits account for 9% of all frauds (ACFE 2020 RTTN) and face specific risks that make them particularly susceptible.
1. Inadequate resources for financial oversight

Of the roughly 1 million public charities in the United States, about three-quarters have annual expenses of less than $500,000.  Small not-for-profits often lack the resources for strong internal controls such as segregation of duties.
2. Excessive control in one person

Especially in small not-for-profits, the founder or executive director may be responsible for almost everything – from writing checks to approving vendors. This lack of segregation of duties creates a seedbed for fraudulent behavior. Tenure and level of authority also positively correlate with the magnitude of the fraud. Executives commit frauds with a median loss 10 times those caused by employees, and employees with more than 10 years of tenure are responsible for median losses 2½ times those caused by employees with less than five years of experience, according to ACFE’s 2016 Report to the Nations.
3. All-volunteer boards with little or no financial oversight

The risk of too much control concentrated in the hands of the executive director indicates a need for objective oversight from a financially literate board of directors. To meet their fiduciary duty of care, all board members need to understand how to read financial statements and be alert to warning signs of errors, fraud, or abuse. However, unlike many for-profit corporations and larger not-for-profits, smaller NFPs tend not to recruit board members with experience running organizations and overseeing financial responsibilities.
4. Volunteers privy to confidential information

In addition to the board members, volunteers perform many financial functions in not-for-profits, including collecting donations, rental fees, and other payments. In many cases, these volunteers have not been vetted thoroughly, opening the door to a potential fraudster.
5. Nonreciprocal transactions

A donor typically does not receive anything of value in exchange for the contribution except for a letter acknowledging the transaction. In many cases, that contribution is in cash. Both of these facts make it all too-easy to divert those funds.
6. Susceptible to negative publicity

In the 2016 ACFE study, more than 40% of fraud cases were not reported to the police, and the most commonly cited reason was fear of negative publicity. For many not-for-profits, negative publicity and the subsequent hit to donations could sink the organization. That knowledge exerts pressure on many executive directors to keep the fraud quiet, and the very fact that so many of these cases go unreported is an incentive to fraudsters. Because there is no record of their malfeasance, subsequent employers are none the wiser. Of the repeat offenders who perpetrated major embezzlements in the last five years, about one in six stole from not-for-profits or religious organizations.

REDUCING THE RISK OF FRAUD-IDENTIFY THE TYPES OF FRAUD
Due to these unique risks, if your not-for-profit organization hasn’t already suffered an instance of fraud, then there is a decent chance that you will discover one soon. And, if so, it likely has been going on for months or even years.

But you can change the ending of this story. According to the ACFE, 29.3% of fraud cases are due to a complete lack of internal controls. Choose your own adventure by instilling a strong anti-fraud culture and a set of controls that are targeted to your organization’s unique risks.
Start by identifying the types of fraud that could be perpetrated by your employees, board members, or volunteers. Some of the typical types of fraud experienced by not-for-profits include:
• Billing fraud, including credit card abuse, charge personal items to organization, creation of fictitious vendors, or billing for personal items or marking up goods or services excessively. Frequency: 30% of all fraud cases, according to ACFE.

• Skimming, in which funds are diverted before they are ever recorded on the books. This fraud is most likely to happen when the funds are in the form of cash. Frequency: 15% of fraud cases.

• Expense reimbursement fraud, in which an employee claims reimbursement for fictitious or inflated business expenses to include mischaracterized expenses, fictitious expenses, and multiple reimbursements. Frequency: 23%.

• Check and payment tampering, a scheme in which an employee intercepts, forges or alters a check. Frequency: 14% of fraud cases.

• Payroll manipulation, which includes fraudulent timekeeping, fictitious employees, and continued payment of terminated employees. Frequency: 12%.

• Corruption, in which an employee abuses his or her influence in a business transaction including bribery, kickbacks, illegal gratuities, economic extortion, and collusion. This situation includes board members or executives with conflicts of interest, as well as bribing. Frequency: 41% of fraud cases.

FRAUD RISK ASSESSMENT KEY QUESTIONS TO DETERMINE YOUR RISK

Armed with an understanding of potential types of fraud and the demographics of fraud perpetrators, executive directors and board members should ask and answer some key questions that can illuminate gaps in internal controls. This process is also known as a fraud risk assessment.

The overall question a nonprofit should be asking is:

What are the business processes and controls around functions where money is coming in and going out of the organization?
Specific questions include:

• What is the tone at the top with respect to ethical behavior?

• How often is management reviewing financial transactions?

• Do we have a written conflict of interest policy? Are officers, directors, and key employees required to annually disclose interests that could give rise to conflicts?

• Do we have a written whistleblower policy?

• Do we have a written accounting policy handbook that identifies each significant accounting position and describes job responsibilities?

• Does the accounting policy describe processes and internal controls related to each major transaction cycle? Does it spell out who should have corporate credit cards and who can write and sign checks?

• Do we regularly monitor and enforce compliance with each of the above policies?

IMPLEMENT CONTROLS FOR FRAUD PREVENTION, FRAUD DETECTION, AND FRAUD CORRECTION TO MITIGATE RISKS
With an understanding of areas where fraud is likely to occur, any organization can implement simple controls to mitigate those risks by implementing internal controls that fall in the three primary areas of prevention, detection, and correction.
Fraud Prevention

The first line of defense includes measures that prevent perpetrators from committing an act of fraud.

For example:

Segregation and/or rotation of financial duties. The person who initiates a transaction shouldn’t approve that transaction, and the person who approves the transaction should be different from the person who records it.

Credit card policies. Credit card accounts are akin to cash and should only be assigned to employees who have a clear need to use them, such as purchasing managers. Bookkeepers, with no need to make purchases, should not have credit cards. When individual cards are required, consider credit purchase contracts for employees outlining utilization responsibilities and rules, and restrict accounts with spending limits and merchant accounting codes.

Dual signatories. Requiring two signatures on checks above a certain amount (both of which are from individuals who did not write the check) reduces the likelihood of check fraud.

Access controls, such as strong passwords for accounting systems, restrict access and also increase traceability of actions.
Background checks. In addition to prospective and current employees, also scrutinize vendors and volunteers who are involved with financial transactions.

Fraud Detection

Due to their limited resources, many small organizations can’t afford to implement robust preventive controls. Ongoing oversight through detective controls can provide the safety net such organizations need. These controls include:

Hotline policy. This control is consistently the most common method of initial detection among frauds reported to ACFE. As shown in our symphony example, more than 47% of frauds reported in the 2016 ACFE report were detected initially through a tip from a whistleblower.

Internal audits of financial statements (comparing actual to budget and investigating any variances), as well as credit card charges, expense reports, payroll records, and petty cash. Internal audits were the second most common method of initial detection (18.4%), according to ACFE.

Management review of bank statements, credit card statements, canceled checks, and invoices. Management review was the third most common method of initial detection (12.1%)

External audits of financial statements, as well as of internal controls over financial reporting. These audits may not be cost-effective for many smaller organizations. While an external financial statements audit was the most common anti-fraud control reported by ACFE respondents, only 1.8% of frauds were detected by an external audit. The reason is that financial statement audits are not designed to detect misappropriation of assets, although auditors do assess fraud risks and procedures set-up to mitigate these risks.

Fraud Correction

Sometimes the best defense is a good offense. If would-be fraudsters know that they will be prosecuted to the full extent of the law, then they will likely think twice about targeting your organization. An effective fraud policy should include the following components:

Internal investigation. A forensic accounting investigation may be necessary to quantify the loss, determine how it was perpetrated, and track the money. This analysis may be necessary to support a prosecution or insurance claim(s).

Interviews. In addition to interviewing the suspect, other employees, board members, and volunteers may need to be interviewed.

External investigation. Pursuing prosecution creates a permanent record that can be discovered by other organizations where the perpetrator may seek employment or volunteer positions in the future.

Be sure to seek legal counsel in establishing any policies, as well as in executing those policies in the case of an actual fraud.

PUTTING POLICY INTO ACTION
We’ve outlined a number of policies that you can use to rewrite your organization’s story.
Here is an action plan that any size organization can use to putting these policies into action:

1. Set the right tone. In addition to creating written conflict-of-interest, whistleblower, code of conduct and accounting policies, distribute hard copies of those policies at least annually. Most importantly, talk about the importance of ethical behavior and the consequences of not living up to the organization’s code of conduct and other policies.  Put policies in writing and have all employees sign documents saying they understand and will follow the rules.   You should discourage a “win at all costs” attitude so the employees and volunteers aren’t encouraged to bend rules, falsify records, or commit fraud in order to meet expectations.

2. Know your team and hire the right people. Unfortunately, perpetrators of fraud often go on to commit schemes at other organizations, disproportionately at nonprofit and religious organizations. Conduct background checks of all prospective employees and volunteers who will be handling financial transactions to put job applicants on notice that the organization values integrity.  Also conduct periodic background checks of current employees and volunteers.  A great deal can be learned from a candidate’s references, work history, credentials, pre-employment drug testing, and criminal background checks.

3. Recruit at least one financially savvy board member who is capable of overseeing your organization’s fraud risk. Educate that person regarding risks specific to your organization.

4. Train board members, employees, and volunteers to be aware of and watch for signs of fraud.  Pay attention to rumors of changes in an employee’s behavior or lifestyle. Red flags include living beyond one’s means, gambling problems and other evidence of financial difficulties, an unusually close relationship with a vendor, and control issues.  You need to educate employees and volunteers to know what to look for to identify fraud and how to report it and provide training as needed.

5. Become involved in the financials, with a focus on anomalies. Frauds discovered by management review and other proactive controls showed the greatest percent reduction in median fraud losses.

6. Create an easy and comfortable method for reporting suspicions. Keep in mind that, while employees are the primary source of tips about fraudulent activity, they may also come from outside sources – such as vendors, customers, competitors, and anonymous sources. Create a mechanism, such as an anonymous hotline, that is accessible by any of these sources.  Cost and fear of notoriety keep some organizations from exposing fraud and taking legal action, but lax attitudes make it easier for the next person to commit fraud with the fear of reprisal.

7. Perform a fraud assessment. Consider a review of your fraud risks every three years, or more frequently if your organization does not perform regular internal audits.  You need to make sure you have internal controls in place that are preventive and detective for fraud.  Mandatory vacations and job rotation make it difficult for an employee to continue to conceal a crime.  You need to have appropriate personnel policies and procedures and make sure policies are applied fairly and equally.   An employee assistance program can help prevent fraud by providing professional help with personal problems such as alcoholism, drug abuse, marital problems, or gambling.

If you’re looking for help identifying fraud risks and implementing cost-effective internal controls to mitigate those risks, contact us for our free assessment about your current situation and how we can help. But most importantly, don’t wait until a fraudster strikes your organization.  We can help you ask the right questions and determine the red flags for fraud.  Please contact us to discuss our certified fraud examination services for fraud prevention and forensic accounting which are available as a CFO service.

Understanding the 501(c)(3) Public Support Test

We have found the public support test to be among the least understood topics by nonprofits, especially smaller organizations.  But, it is absolutely critical to understand how it works, lest your nonprofit lose its public charity status.

Background

Before we get into the specifics of the public support test itself, it’s helpful to step back a bit and talk about a subject we’ve covered before, namely, private foundations vs. public charities.  Both organizational types are considered tax-exempt 501(c)(3) nonprofits, but the requirements regarding donor support are quite different.  Private foundations are typically closely-governed nonprofits, and the purpose of most private foundations is to fund the work of public charities.  In addition to being allowed to have close control, private foundations also can be closely funded, even by just one individual.  Many family foundations are governed and funded by members of a single family.

Public charities, on the other hand, the preferred organizational choice of most 501(c)(3)s, are expected to have both diverse control and diverse funding.  On the control side, the IRS expects charity boards to have a majority of members who are unrelated by blood, marriage, and outside business ownership.  As for funding sources, charities are required to have a broad base of public support, which is where the public support test comes in.

How It Works

The simplest definition of the IRS public support test states that at least 1/3 (33.3%) of donations must be given by donors who give less than 2% of the nonprofit’s overall receipts.  Exceptions include any gifts received from other donative public charities and/or a government source, such as a state or federal grant.  For organizations that also get funds from sales of goods or services (this is called program revenue), such revenue counts toward the public support test also.

As you can expect with IRS compliance issues, however, it’s much more complicated that it appears.  There are several subcategories of 501(c)(3) public charities, including 509(a)(1), 509(a)(2), 509(a)(3), and 509(a)(4).  We’ll focus primarily on 509(a)(1) and (a)(2).  When an organization first requests 501(c)(3) determination from the IRS, the Form 1023 application asks which subcategory the nonprofit is seeking status under, based on its purpose, programs, and revenue sources.  509(a)(1) status has several sub-subcategories, some of which are self-defining by the organization’s purpose:  church (170(b)(1)(A)(i)), school (170(b)(1)(A)(ii)), hospital (170(b)(1)(A)(iii)).  Others falling into 509(a)(1) are more generically defined by source of revenue (donations and grants), assuming their purpose doesn’t fit a predefined category.  They are considered 509(a)(1)/170(b)(1)(A)(vi).

509(a)(2) are those charities that are not slotted into 509(a)(1) status by virtue of purpose, plus have a mix of donor support and program revenue.

At this point, you may be getting lost in the weeds.  But stick with us…the public support test is calculated differently on Form 990, Schedule A, depending on 509(a)(1) or 509(a)(2) status, and source of revenue.

Let’s consider some examples:

ABC CHARITY, INC. – Scenario 1:

ABC Charity is a 509(a)(1) public charity that receives substantially all of its support from donations from individuals, families, and businesses.  Here’s how the numbers break out.  Assuming the organization brought in exactly $1,000,000 in cumulative donations over the past 6 years, at least $333,000 must have come from donors giving less than $20,000 each (cumulatively) in order to pass the public support test.  Here’s how their numbers broke out:

Total donor support:  $1,000,000

Total support under 2% (< $20,000):  $882,000

Total support above 2% (>=$20,000):  $118,000

Public support percentage:  88.2%

ABC CHARITY, INC. – Scenario 2:

Instead of individual support only, let’s say ABC Charity also received donations from several other public charities.  How does that affect the calculation?

Total donor support:  $1,000,000

Support from public charities:  $425,000

Individual support under 2%:  $115,000

Individual support over 2%:  $465,000

In this case, the public support test is a little more complicated.  Donations received from other public charities is often considered public support, regardless of amount, but not always.  For the most part, the donating charity needs to be a 509(a)(1)/170(b)(1)(A)(vi) organization or a church.  Schools, for example, are 509(a)(1) nonprofits, but donations above 2% do not count as public support.

Assuming the $425,000 above is from other 170(b)(1)(A)(vi) organizations, the calculation on this one is $425,000 + $115,000 = $535,000, for a resulting 53.5% public support.  If not, the $425,000 would have to be further broken out and part of it moved into the “over 2%” column.

XYZ NONPROFIT, INC. – Scenario 1:

XYZ Nonprofit’s situation is different from ABC’s.  While XYZ, a children’s dance school, does gladly accept donations, it also receives part of its revenue from participation fees and from selling tickets to its performances.  As such, it is sub-classified as a 509(a)(2).  Let’s see how their numbers work:

Total revenue:  $1,000,000

Participation fees (program revenue):  $760,000

Ticket sales (program revenue):  $80,000

Individual support under 2%:  $60,000

Individual support over 2%:  $100,000

XYZ’s resulting public support percentage is 90% ($760,000 + $80,000 + $60,000 = $900,000).

There are many more scenarios we could present, but this sample gives you an idea of how complex this can be.  We need to additionally point out that the public support test is calculated on a 5-year cumulative basis, not any individual year.  In addition, the IRS does not require new public charities to demonstrate public support until year 6.

Why Does It Matter?

Failure to pass the public support test will result in your nonprofit having its public charity status retroactively reverted to private foundation.  For the majority of nonprofits, that would be a potentially devastating outcome.  Private foundation status is ideal for those organizations that specifically need that structure.  For charities that find themselves downgraded, however, the consequences include having to file Form 990-PF for 6 prior years, along with the potential for loss of charitable deductibility for larger donors, again retroactively.  Even worse, the organization cannot convert back to a public charity for at least 5 forward years.

There IS a Possible Escape Clause

Even if your nonprofit fails the public support test, it may still be possible to retain public charity status, so long as your public support is at least 10%.  When that happens, charities must fall back on what’s called the facts and circumstances test.  It’s a subjective request to the IRS on Form 990, Schedule A to allow the organization to retain charity status.  The organization must assert that it is operating as a charity, not a foundation, and that they are actively working to get their public support percentage back up to 33% or more.  There’s no guarantee that the IRS will grant the request, but typically they do if the situation seems reasonable.

It is entirely possible to fall into this situation multiple years in a row.  It is certainly a risk, as this is a subjective IRS decision.  But, we have seen nonprofits take 2 or more years to get back above water and still retain status.  Should your public support test drop below 10%, however, and your nonprofit WILL be downgraded.

Wrapping Up

The public support test is critically important.  Understand how it works, keep great records, and work hard to ensure your charity has at least 33% public support.

Beyond Financial Oversight: Expanding the Board’s Role in the Pursuit of Sustainability

This article is reprinted from NPQ’s spring 2011 edition, “Governing amid the Tremors.” It was first published online on April 26, 2011.

Throughout the ten years prior to the recession, it seemed that whenever anyone talked about boards and finances in the same sentence they were making a point about accountability. They were warning us that our Form 990s were now on GuideStar, so we’d better make sure that our boards were reading them. They were telling us to have an audit committee and a “Conflict of Interest” policy. They were telling us that we should study Sarbanes-Oxley and apply whatever we could to our own boards. They were making constant reference to a handful of nonprofit fraud cases, suggesting that this was what awaited us if our boards did not get very serious about oversight and accountability.

Now, as community-based organizations continue to weather the severe, and in many cases permanent, shifts in their operating environments caused by the recession, those accountability concerns seem downright quaint. The truth is that one of the roles that most decently functioning boards play quite well is providing financial oversight. Compared to other board functions, financial oversight is relatively clear: there is a dedicated officer role, the treasurer; nearly all boards have a finance committee; and there are tangible products such as an annual budget to approve, financial statements to distribute, and an auditor to select.

The problem is none of those tangible products in and of themselves has anything to do with nonprofit sustainability. And it is sustainability that is keeping executive directors up at night, not financial oversight. In a new book I coauthored, Nonprofit Sustainability: Making Strategic Decisions for Financial Viability, my colleagues and I define sustainability as being both programmatic and financial:1

Sustainability encompasses both financial sustainability (the ability to generate resources to meet the needs of the present without compromising the future) and programmatic sustainability (the ability to develop, mature, and cycle out programs to be responsive to constituencies over time).

In other words, board finance committees can look at annual budgets, financial statements, and audits forever, but if some group of board members is not considering those financial results in light of the organization’s programming mix and its results, then their efforts are very unlikely to contribute to sustainability.

Our boards, not unlike many of our staffs, are artificially siloed into groups that consider financial results, groups that consider programmatic results, and groups that consider fundraising results. Yet, for those of us without an endowment or many wealthy annual donors, program results in large part drive financial results. It is how many clients we case-manage that yields a particular contract reimbursement. It is how many units of housing we build that yields a particular developer’s fee. It is how popular our new play turns out to be that yields a particular box office revenue. And just as critically, it is how many people respond to our direct mail campaign and to our special event invitation that determines how much subsidy we can raise for programs that don’t cover their own costs. Put another way, if the board finance committee doesn’t like the financial results it is seeing as it provides oversight, what is it going to do about it? It has to look to the programs and the fundraising activities of the organization to yield different financial results; that’s the only way to make the financial statements say anything better.

So while financial oversight is absolutely critical, it is hardly sufficient. Boards of directors charged as stewards of an organization have to be fundamentally knowledgeable about and actively engaged in the business models of the organizations they govern. And nonprofit business models are typically the antithesis of siloed; they are instead a very interdependent mix of programs and fundraising activities that work together to achieve a set of impacts and financial results. How engaged are most boards in that interdependence? And if they are not engaged, how can they meaningfully assist with the dogged pursuit of sustainability in which so many of their executives find themselves?

The complex challenges facing community-based nonprofits require that we shift our mental model from boards being primarily about financial oversight and accountability, to boards being concerned in an ongoing way with the financial sustainability of their organizations.

Is Your Board Sustainability-Focused?
If you are considering making the pivot from an oversight orientation to a sustainability orientation, consider using these discussion questions to start off the conversation at your next board meeting:

  1. How financially literate are we as a group? If we have knowledge gaps, how will we work together to close them, and by when?
  2. Is our finance committee engaging in the key business-model questions facing our organization, or is it focused primarily on monitoring budget variance and preparing for the audit?
  3. What major sustainability decisions are before us as an organization, and how will we structure our board and committee-meeting agendas over the next three to four months to ensure we make those decisions effectively?
  4. Overall, how healthy is our organization financially? Is it healthier today than it was three years ago? Why or why not? When our board terms end, where do we want to leave the organization financially?
  5. How strong is our partnership with staff leadership around issues of sustainability? Are we sharing information and ideas across staff and board in a way that truly leverages our individual and collective strengths and networks as board members in the sustainability pursuit?

When pivoting a board of directors from a strictly oversight orientation to a sustainability orientation, there are a number of things to consider. For instance, a board with a sustainability orientation requires board members who are financially literate. By this I mean that everyone has, or is actively developing, an understanding of the financial statements they receive. They have the fluency, for instance, to ask how a core program is performing both financially and programmatically. If only two or three people on the board can read the financial data, the board is unlikely to have holistic conversations that take both mission impact and financial return into account. With a sustainability orientation, financial statements become a useful tool in the ongoing discussion of where the organization should go next rather than merely reports that the treasurer assures everyone she has reviewed on their behalf.

Practically, this means that board chairs and executives need to team up in creating a board culture that expects and supports financial literacy from all members. During the recruitment and orientation of new board members, thorough and transparent discussion of the organization’s business model and its current financial challenges and opportunities should be central. A board with a strong sustainability orientation will most likely pass on the potential recruit who uses stale language such as, “I am not a numbers person. I leave that stuff to the treasurer.” The response should be, “Our board is focused holistically on the sustainability of this organization, so everyone engages with our financial results. We will train you and support your development as a financial leader, but you have to be committed to our stance on this point to be successful on this board.” In addition to this kind of strategic recruitment and orientation, board chairs and executives should prioritize financial training opportunities and consider mentoring among board members to support members who are in active development of their financial literacy. Once a year, all board members should receive a one-hour refresher on how to read and interpret the organization’s particular set of monthly financial statements.

To signal and reinforce this sustainability stance, chairs and executives should consider renaming their finance committees and adding nontraditional members—folks who are financially literate but who have program or fundraising as their primary orientations, for instance. A board committee called “Finance and Sustainability” that is composed of both finance experts and programmatic folks actively engaging with the business model’s concerns will support the pivot to a “beyond oversight” board. When a diverse group of members is reviewing and discussing the numbers, not only can it go beyond merely reporting to the full board how close to its budget the organization is or is not, it can also frame for the board the questions of “why?” and “what might we do about it?” With this approach, the treasurer role evolves from that of a CPA, who is among the only people able and willing to review financials, to a full leadership role that supports the full board’s meaningful focus on the complex questions and difficult decision making of the sustainability pursuit.

Another key shift required for a sustainability orientation is the normalizing of profit. Profit, like program impact, is fundamental to sustainability. A board of directors that is uncomfortable budgeting for surplus and unwilling to face the brutal facts about the prospects for profitability of core activities is not operating with a sustainability orientation. It is important not to conflate profitability with earned income, however. Many community-based nonprofits achieve profitability—that is, consistent annual surpluses—through a mix of earned and donated income. A special event can be just as profitable as a fee-based service to the community. The key is for boards to be looking for profit wherever it can be generated in the model, and to be ensuring that, as a set, the organization’s activities yield more than they consume.

Through the recession, many leaders have had to face the reality that they can no longer subsidize core activities that do not cover their own costs. The fact that an activity is core to an organization’s mission and very needed by its constituency does not necessarily mean that the organization can afford to keep it in its business model. So many executives I talk to now lament not having faced those realities sooner. I attribute this reticence to act on unsustainable deficits in part to boards of directors not deeply engaging in why and how their organizations were incurring deficits. That is, they didn’t deeply understand which activities in their business models were losing money, and how much; instead, they talked in macro terms about the organization’s overall “not hitting budget.” Part of pursuing sustainability is determining the desired profitability of every core activity—programmatic and fundraising. While most community-based organizations will elect to subsidize a handful of money-losers—allow the profits from an annual event to offset the losses in the government-funded job training program, for instance—the board should be very clear on these decisions and ensure that those subsidy decisions do not result in deficits for the organization overall.

The nature of financial plans and reports shifts too with a sustainability orientation. Ironically, the classic tools of annual budget, monthly financial statements, and an audit can actually keep a board focused on oversight rather than business model sustainability. When boards focus too much on annual budget variance, for example, I find that they are often not sufficiently engaging in projection. Rather than focusing all of their analytical energy on how close the organization is to numbers it predicted six or eight months ago, members of the Finance and Sustainability Committee want to be anticipating the next several quarters’ results, too. We spend too much time providing oversight on things that already happened, and not enough time considering the financial road ahead. For-profits engage in rolling projection, and I believe that nonprofits should do this as well.

Rolling projection moves the board of directors away from the silly obsession with “hitting the year-end budget” and toward the capacity to make earlier and better decisions given the economic forces happening in real time. Fiscal years are artificial time frames. All major decisions will have economic impact far beyond the current fiscal year. Put another way, it is just as important to have a good July as it is to have a good June. When boards focus only on predicting the coming twelve months (annual budget), monitoring variance from that increasingly outdated prediction (monthly financial statements with budget variance), and reviewing the past year’s statements (audit), they risk not actually engaging in the pressing and emerging business issues facing their organizations right now. Again, financial oversight is critical but insufficient for sustainability.

A board that is focused on sustainability will be working a handful of key business-model issues all the time. In this economic climate, very few community-based organizations do not have to rethink some aspect of their business models. The Finance and Sustainability Committee members will partner with staff leadership to articulate those issues and find meaningful ways for the full board to understand them and, where possible, contribute to their resolution. For instance, the committee may come to the realization that the organization needs to close or transfer its drop-in program for teen dads because, while valued by the community, it has lost money for three years in a row, and its government contract is unlikely to survive the next round of county budget cuts. A committee member can partner with the executive director to craft a presentation to the full board, laying out the data and framing the key questions for board decision making: Are we prepared to end this program, and if so, by what date? Are there elements of this program that we can transfer to a collaborator or competitor? Are there financial implications of closing this program that we need to understand (for example, laying off staff, alienating a key funder, or losing the contract’s modest contribution to defraying overhead costs)? One board member can be engaged in reaching out to another community organization about the potential for program transfer; another board member can join the executive director in breaking the news to the government funder; and so on. In this fashion, the full board is actively engaged in decision making and execution on a business-model issue essential to the organization’s sustainability.

For too long, too much of our boards’ finance focus has been on reviewing the past. For many nonprofits, this meant decision making was too slow in the face of the mounting recession. Modest reserves were depleted, and organizations were left exceedingly vulnerable during a time of great community need. The lesson of the recession is that boards must engage not only in financial oversight but also in the pursuit of sustainability. To do this well, boards have to be composed of financially literate members who engage in real-time analysis and focus on answering the complex business-model questions their organizations face today.

Notes

  1. Jeanne Bell, Jan Masaoka, and Steve Zimmerman, Nonprofit Sustainability: Making Strategic Decisions for Financial Viability. San Francisco: Jossey-Bass, 2010.

IRS improves online Withholding Estimator to reflect new W-4 for 2020

The Internal Revenue Service unveiled an enhanced Tax Withholding Estimator on its website Tuesday, designed to help workers fill out the new W-4 withholding form and hopefully avoid the problems seen last year when many taxpayers found themselves owing more taxes or receiving less of a tax refund than they expected.

The new Tax Withholding Estimator incorporates the changes from the recently revamped Form W-4, Employee’s Withholding Certificate, that employees can fill out and give to their employers this year.

The IRS is encouraging taxpayers to find out if they need to adjust their withholding by using the Tax Withholding Estimator to do a Paycheck Checkup. If an adjustment is needed, the Tax Withholding Estimator offers recommendations on how to fill out their employer’s online Form W-4 or provides the PDF form with key parts filled out.

To assist workers with more effectively adjusting their withholding, the enhanced Tax Withholding Estimator offers a customized refund slider that enables taxpayers to select the tax refund amount they prefer from a range of different refund amounts. The exact refund range shown is customized based on the tax information entered by that user.

Based on the refund amount selected, the Tax Withholding Estimator will give the worker specific recommendations on how to fill out their W-4. The new feature permits users who prefer either larger refunds at the end of the year or more money on their paychecks throughout the year to have just the right amount withheld to meet their preference.

The new Tax Withholding Estimator also offers a number of other improvements over last year’s version, including one enabling anybody who anticipates receiving a bonus from their employer to indicate whether tax will be withheld. On top of that, improvements added last summer by the IRS continue to be available in the latest version of the app, including mobile-friendly design, handling of pension income, Social Security benefits and self-employment tax.

The Tax Cuts and Jobs Act of 2017 eliminated a host of traditional features of the Tax Code, including the personal and dependent exemptions that had long been the key ways that employees were filling out their W-4 forms. The IRS was slow to revise the W-4 form after some early draft versions of the W-4 prompted complaints that it was asking for too much information, such as about a spouse’s income. The IRS finally released a new W-4 form last month (listen to our podcast episode Meet the new W-4 to hear more about it). But that was too late for many taxpayers who discovered last tax season that they ended up owing thousands of dollars on their tax bills when they were accustomed to receiving tax refunds every year. Even though the Tax Cuts and Jobs Act reduced the overall tax burden for most taxpayers, the actual tax cut for many workers was so small that many people never noticed the difference on their paycheck, particularly if other items like health insurance went up.

The changes may be even more dramatic this year. Starting in 2020, the IRS noted, income tax withholding is no longer based on an employee’s marital status and withholding allowances, tied to the value of the personal exemption. Instead, income tax withholding is typically going to be based on the worker’s expected filing status and standard deduction for the year. In addition, workers can choose to have itemized deductions, the Child Tax Credit and other tax benefits reflected in their withholding for the year.

The IRS stressed the importance of people who have more than one job at a time (including families in which both spouses work) to adjust their withholding to avoid having too little money in taxes withheld from their paychecks. The revamped Tax Withholding Estimator promises to provide a more accurate way to do this. As in the past, employees can also opt to have their employer withhold an extra flat-dollar amount each pay period to cover, for example, the income they receive from a gig economy side job, self-employment income, or other sources that aren’t subject to withholding.

Nonprofit Tax Alert: Parking Tax REPEALED

As part of a bipartisan year-end spending and tax package agreed to this week, Congress repealed IRC Section 512(a)(7) that required tax-exempt organizations to pay a 21% unrelated business income tax (UBIT) on qualified transportation benefits provided to employees (the “Parking Tax”).

President Trump is expected to sign this legislation today to avoid a partial government shutdown at midnight December 20. Once signed, the repeal of the “Parking Tax” is retroactive to the original date of enactment. Taxpayers should be able to file amended Form 990-T to claim a refund for any UBIT paid related to providing qualified transportation benefits to their employees after December 31, 2017.

The legislation also amends IRC Section 4940 private foundation excise tax on net investment income to a single rate of 1.39%. The 1% or 2% tax rates have been eliminated. This single rate rate of 1.39% will be effective for tax years beginning after the legislation’s date of enactment.  The new rate is effective for tax years beginning after December 20, 2019.

For additional details, refer to the law (H.R. 1865, Division Q, AKA the Taxpayer Certainty and Disaster Tax Relief Act of 2019, SECs. 207 and 302) or visit irs.gov/charities-and-nonprofits.

As always, let us know if you have any questions.