On July 21, 2023, the IRS released a generic legal advice memorandum (GLAM) that clarified its interpretation on Employee Retention Credit (ERC) eligibility based on supply chain disruptions.1 While IRS memoranda are not to be cited or used as precedent, they nevertheless signal the position that the IRS intends to take on a matter. In this GLAM, the IRS left readers assured that it views a supply chain disruption, by itself, as wholly insufficient to qualify a business for ERC.
Briefly, the ERC is a refundable payroll tax credit intended for employers that retained employees despite being impacted by the COVID pandemic. Employers seeking this significant relief measure are “eligible employers” if they can show: (1) significant declines in quarterly gross receipts (as compared to corresponding quarters in 2019), or (2) that they experienced a full or partial suspension of business operations due to governmental orders in response to COVID.
Undoubtedly, numerous employers faced challenges during the pandemic due to supply chain disruptions. As the IRS notes in its GLAM, statutory language doesn’t expressly address supply chain disruptions. Rather, the IRS introduced the discussion in March of 2021 in its Notice 2021-20, Q/A-12:
Question 12: If a governmental order causes the suppliers to a business to suspend their operations, is the business considered to have a suspension of operations due to a governmental order?
Answer 12: An employer may be considered to have a full or partial suspension of operations due to a governmental order if, under the facts and circumstances, the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations. If the facts and circumstances indicate that the business’s operations are fully or partially suspended as a result of the inability to obtain critical goods or materials from its suppliers because they were required to suspend operations, then the business would be considered an eligible employer for calendar quarters during which its operations are fully or partially suspended and may be eligible to receive the employee retention credit.
In its GLAM, the IRS analyzes five fact patterns involving employers claiming ERC eligibility as a result of supply chain disruptions. Unsurprisingly, the Service concludes that none of the five scenarios demonstrate a supply chain disruption which rises to the level of a full or partial suspension for ERC purposes. Indeed, the IRS takes this opportunity to qualify Notice 2021-20, Q/A-12, as providing “a narrow, limited exception.” According to the IRS:
The guidance provided by section III.D., Q/A-12 of Notice 2021-20 allows the employer to “step into the shoes” of its supplier for purposes of the suspension test. To meet the terms of this exception, as explained in Q/A-12, the supplier must have been subject to a governmental order that causes the supplier to suspend its operations. In addition to having a governmental order, the employer must substantiate its eligibility for the credit by providing records or documentation demonstrating that (i) the governmental order caused the supplier to suspend operations, (ii) the inability to obtain the supplier’s goods or materials caused a full or partial suspension of the employer’s business operations, and (iii) the employer was not able to obtain these critical goods or materials from an alternate supplier. See Section III.N., Q&A 70 of Notice 2021-20; see also Treas. Reg. § 31.6001-1 and Treas. Reg. § 1.6001-1. If the facts and circumstances dictate that the employer’s operations are fully or partially suspended because of the governmental order suspending the supplier from providing the critical goods or materials, then the employer may be considered an eligible employer under the guidance provided by Q/A-12.
In other words, the IRS will require employers substantiate: (1) relevant governmental orders imposed upon a supplier that disrupted the supply chain; (2) how such orders directly caused a supplier to suspend operations; (3) the employer’s own inability to obtain critical supplies due to the supplier’s suspension; and (4) how the supply chain disruption led to the employer’s own full or partial suspension of business operations.
As a basis for ERC eligibility, the supply chain disruption is narrow and limited, according to the IRS. While the GLAM is technically only an interpretation on the matter by the IRS—it’s not law—anyone challenging it would have an uphill battle of deconstructing the IRS’s position. So, it’s important for readers to realize that anyone being counseled to take positions that don’t align with the GLAM’s parameters should be wary. The IRS has put everyone on notice as to its position. And if the IRS challenges an aggressive ERC claim based on a supply chain disruption that deviates from the position outlined in the GLAM, the employer may have to go to court and try to defend its contrary posture. If you need help with your ERC claim contact our team today at (410) 497-5947 or schedule a confidential consolation here.