The IRS Chief Counsel recently released a Generic Legal Advice Memorandum (GLAM) addressing the employee retention credit (ERC) and supply chain disruptions.
IRS Chief Counsel memorandum is legal advice issued to IRS personnel. According to the IRS website, memorandums “are issued to assist Service personnel in administering their programs by providing authoritative legal opinions on certain matters, such as industry-wide issues.” Although a GLAM can’t be used or cited as precedent, it does give insight into the legal position the IRS will take on an issue. In this instance, that issue is the ERC.
In question #12 of Notice 2021-20, which lists rules, guidance and Q&A relating to the ERC, the IRS shared a very specific scenario whereby an employer could obtain ERC eligibility based on their supply chain being disrupted. Keep in mind that an employer must be able to show that a full or partial suspension due to a governmental order affected its supplier.
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.
Example: Employer A operates an auto parts manufacturing business. Employer A’s supplier of raw materials must fully suspend its operations due to a governmental order. Employer A is unable to obtain these raw materials from an alternate supplier. As a consequence of the suspension of Employer A’s supplier, Employer A is not able to perform its operations for a period of time. Under these facts and circumstances, Employer A would be considered an eligible employer during this period because its operations have been suspended due to the governmental order that suspended operations of its supplier.
The IRS memorandum presents five scenarios where employers are making a case for their ERC eligibility based on various supply chain issues they ran into. The memorandum starts with an analysis that examines how the supply chain issues align with the statutory provisions of the ERC. This analysis highlights the fact that the presence of a supply chain disruption alone, without causing an actual full or partial suspension of an employer’s business, isn’t enough to call for ERC qualification.
The employer must be able to present the following necessary documentation and evidence to prove ERC eligibility based on supply chain disruptions to defend an ERC claim:
- Specific government orders: Documentation that proves the existence of relevant government orders imposed on a supplier that affected the supply chain.
- Supplier issues caused by the order: Evidence illustrating how the government orders or other issues directly caused challenges for the supplier, forcing the supplier to suspend operations.
- Critical supplies weren’t able to be obtained: Documentation showing the employer’s inability to obtain critical and necessary supplies due to the issues faced by the supplier.
- Employer’s business was impacted: Clear documentation highlighting how these supply chain issues led to a full or partial suspension of the employer’s own business operations.
Employers interested in claiming the ERC must be aware that a vague belief or some sort of simple questionnaire noting supply chain issues will not be enough to sustain the claim if it were to be examined by the IRS. The burden of proof of eligibility in these examinations lies with the employer, and, therefore, getting significant and specific documentation and evidence that supports the claim is crucially important.
Scenario #1 – Taxpayer had Supplies on Hand
Employer A was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, during 2020 and 2021, Employer A experienced several delays in receiving critical goods from Supplier 1. At all times during 2020 and 2021, Employer A continued to operate because Employer A had a surplus of the critical goods normally provided by Supplier 1. Employer A assumed that Supplier 1’s delay in delivering critical goods was caused by COVID-19. Employer A inquired and Supplier 1 vaguely confirmed that the delay was due to COVID-19. Supplier 1 did not provide a governmental order from an appropriate governmental authority and Employer A was unable to find one.
Due to the employer not being able to provide the government order that impacted the supplier, it’s not eligible for the ERC. The employer would also not qualify due to the fact that they never experienced a shortage of critical supplies at any point.
Scenario #2 – Supplies Restricted Due to Bottleneck at Port, Along With Multiple Causes and Government Order Not Identified
Employer B was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, certain critical goods from Supplier 2 were stuck at port in State X. Employer B assumed the bottleneck at the port was a result of COVID-19. Employer B could not find any specific governmental order applicable to Supplier 2 or any specific governmental order that caused the bottleneck at the port. Some news sources said that COVID-19 was the reason for the bottleneck, while others cited reasons such as increases in consumer spending and aging infrastructure. In addition, Supplier 2 mentioned to Employer B that other critical goods that were not stuck at port would be delayed due to a truck driver shortage. Employer B saw some discussion on social media that the truck driver shortage was because drivers were out sick due to COVID-19.
The inability to obtain critical goods or materials due to bottlenecks at the U.S. border or port, or due to trucking or shipment delays, doesn’t qualify as a supply chain disruption. Employers need to name a specific governmental order that suspended the supplier’s business and then demonstrate that the supplier’s inability to deliver the critical goods or materials was caused by the governmental order.
Scenario #3 – Disruptions in Supply Chain Continued Past the End of the Identified Government Order
Employer C and Supplier 3 are located in a district that issued governmental orders suspending both of their business operations for the duration of April 2020. Employer C and Supplier 3’s jurisdiction lifted all orders related to COVID in May 2020. For the rest of 2020 and 2021, Employer C experienced a delay in receiving critical goods from Supplier 3. Supplier 3 doesn’t provide a reason for the delay, but Employer C assumes the delay is due to the governmental order in place in April 2020.
The employer can only qualify for the ERC during the period in which the identified government order is in effect. Delays that continue or occur after the supplier’s suspension period don’t qualify as a supply chain disruption.
Scenario #4 – Higher Cost Goods Available From Alternate Supplier
Employer D was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. During 2020 and 2021, Employer D could not obtain critical goods from Supplier 4. However, Employer D was able to obtain the goods from an alternate supplier. The critical goods from the alternate supplier cost 35% more than those from Supplier 4. Employer D could continue to operate its trade or business even though it was not as profitable as in 2019.
There isn’t a supply chain disruption just because critical supplies were more expensive than they were previously — the main factor to look at is whether the employer was prevented from running its business. In this instance, there wasn’t a full or partial suspension of that business.
Scenario #5 – Limited Number of Products Not Available
Employer E operates a large retail business selling a wide variety of products. Employer E was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 in 2021. Due to various supply chain disruptions, Employer E was not able to stock a limited number of products and was forced to raise prices on other products that were in limited supply. However, at no time did the product shortage prevent Employer E from continuing to fully operate as a retail business during 2021.
The impact on the employer’s business was considered too limited to qualify as a partial suspension. The inability to stock a limited number of items didn’t result in a big enough disruption to be considered a partial suspension of business operations (as is needed to claim the ERC).
The new IRS memorandum is consistent with what the agency previously shared in Q&A #12 of Notice 2021-20. The IRS is taking a narrow view of how to apply a supply chain disruption as being a qualifying event for ERC purposes.
If your business has experienced supply chain issues that align with the IRS’s requirements and you haven’t yet applied for the ERC, it’s recommended that you reach out to your trusted tax advisor for next steps. If you don’t have one, Creative Planning can help.
Our tax team partners with clients to help optimize their tax planning strategies. Contact us today with your ERC questions, and our team of tax specialists will make sure they’re addressed.
