Employee Retention Credit Accounting Guidance for Independent Schools

By Christopher S. Maynard, Klatzkin

The Employee Retention Credit (ERC) is one of a handful of federal programs aimed at helping businesses and nonprofit organizations maintain healthy operations through the coronavirus pandemic. For many independent schools, programs like the ERC and the Paycheck Protection Program (PPP) have helped keep people on the payroll while leaders have been faced with difficult decisions about their school’s future. Accounting for the ERC — for example, how and when should ERC funds be recorded — is a concern for many independent schools. 

Which organizations are eligible?

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

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

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

Which accounting guidance should independent schools use?

Since the ERC was introduced in March 2020, independent schools have wondered how to account for ERC funds properly.

Because ERC funds are payroll tax credits, they cannot be treated as income taxes (under ASC Topic 740: Income Taxes), or loans or debt (under ASC Topic 470: Debt).

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

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

Applying ASC Topic 958-605 to the ERC

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

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

• Proving their gross receipts fell in 2021, meaning their gross receipts must be 80% or less than they were in either the comparable quarter from 2019 or the immediately preceding quarter.
• Incurring eligible wages. This calculation will depend on whether the entity is considered a large or small employer. Large employers (those with more than 500 full-time employees in 2019) can only count their wages to stay home. Small employers can include the wages of all employees.
• Not double-counting their wages. The ERC wage calculation excludes wages that the school uses to qualify for:
  • PPP loan forgiveness
  • Work Opportunity Tax Credit (WOTC)
  • Credit for paid family and medical leave under Section 45S
  • Credit for paid sick and family leave under the Families First Coronavirus Response Act

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

Recognizing ERC Income

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

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

Even though the ERC is a payroll tax credit, the revenue should not directly reverse payroll tax expense on the financial statements; offsetting a school’s payroll tax deposits is simply the mechanism by which the government chose to distribute the credit

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

Your school might interpret ASC Topic 958-605 slightly differently than other independent schools, and that’s OK. The most important step is documenting your method consistently in the footnote disclosures, and being consistent with the path you choose.

From our perspective, it is highly important that schools do the following:

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

Christopher S. Maynard, CPA, is a partner with the accounting and advisory firm Klatzkin, where he serves as an advisor and auditor to independent schools and other nonprofit entities.