ERTC Eligibility for Supply Chain Disruption
By Ian Williams, Director, Research & Development Tax Credits and Employee Retention Credits | KBKG
The IRS Chief Counsel recently published a Generic Legal Advice Memorandum (GLAM), providing guidance on the eligibility criteria for the Employee Retention Credit (ERC or ERTC) in cases where employers claimed government shutdown qualification via shutdowns of their suppliers. To claim the ERC, an employer must demonstrate a full or partial suspension of their trade or business during an applicable quarter due to government orders related to COVID-19. There is a provision to qualify if a key supplier was under a government shutdown, but our recent article pointed to the difficulties in documenting and proving qualification under that argument.
The memo clarified that certain employers may claim the credit if their critical goods or materials suppliers were suspended by government orders, leading to disruptions in their operations, and provided a few helpful examples. Brief summaries are provided below, and the full memo with the facts of each scenario can be found here.
The Key Takeaway
The IRS found that 4 out of the 5 did not qualify, because the employer could not prove their supplier had a government ordered shutdown. Example 4 did have qualification for one month where a shutdown order was documented that applied to both the employer and their supplier. Further supply delays claimed beyond that shutdown order could not be tied to a government order and were disallowed.
Summary of the IRS conclusions:
Scenario 1:
Employer A experienced delays in receiving critical goods from a key supplier.
Scenario 1 Conclusion:
Employer A was not eligible for the Employee Retention Tax Credit because they couldn’t show a government order suspending their supplier’s business. Employer A continued to operate despite global supply chain delays and assumed that COVID-19 caused the delays without any evidence of a government order.
Scenario 2:
Employer B experienced delays in critical goods because they were stuck at port.
Scenario 2 Conclusion:
Employer B was not eligible as there was no evidence of a government order causing the bottleneck at the port. Even if the bottleneck could be tied to a governmental order, that order would have to apply specifically to the supplier, neither of which was documented.
Scenario 3:
Employer C and it’s supplier were under government orders suspending business operations from April 2020 through May 2020. For the remainder of 2020 and 2021, Employer C experienced delays in receiving critical goods from it’s supplier.
Scenario 3 Conclusion:
Employer C was eligible for ERC only in April-May 2020 when a government order suspended both their operations and their supplier’s operations. However, they weren’t eligible beyond May of 2020 as there was no evidence of a later government order impacting their operations or their supplier’s operations.
Scenario 4:
Employer D could not obtain critical goods from it’s supplier, but was able to obtain goods from an alternate supplier, at a 35% increase in costs. Employer D continued operating with reduced profits.
Scenario 4 Conclusion:
Employer D was not eligible for the ERC as they never experienced a government suspension order and could obtain critical goods from an alternate supplier at a higher cost.
Scenario 5 Facts:
Employer E operates a retail business with a wide variety of products, some of which they were not able to stock during 2020 and 2021 due to supply chain disruptions.
Scenario 5 Conclusion:
Employer E was not eligible as they couldn’t show a government order suspending their suppliers of critical goods.
KBKG Insight
To summarize, these cases were all or partially disallowed for the following reasons:
- Lack of evidence of a government order suspending the supplier’s business.
- Insufficient proof that supply chain disruptions caused by COVID-19 resulted from specific government orders.
- Failure to demonstrate that the disruptions affected more than a nominal portion of the business’s operations.
- Inability to show that the business couldn’t source critical goods from an alternative supplier.
- Reduced profits are a common misconception, if you had a qualifying reduction in gross receipts then you could potentially qualify via that avenue, but reduced profit margins are not evidence of a government shutdown.
The IRS is still catching up to the unprecedented volume of fraud and abuse in ERC. In addition to the Memo summarized above, the IRS also recently published another FAQ providing further guidance on eligibility, shutdown qualification, gross receipts, recovery start-ups, recordkeeping, and more information on the many ERC scams taxpayers are facing. The IRS also recently published their dirty dozen tax scams list for 2023; ERC didn’t make the list in 2020-2022 but went straight to the top in 2023.
Conclusion
Don’t accept an ERC assessment without doing your homework and making sure that the individual or firm reporting on the ERTC credits has considered all of the facts. If you do engage with a provider to assist in calculating and documenting ERC via government shutdown, make sure they are documenting your specific facts and the specific government orders that apply to your company. Ask yourself whether their reason for qualification is specific to your business or whether it would apply to most businesses.
Most companies experienced supply chain delays during 2020 and 2021. Those delays were undoubtedly directly and indirectly caused by the worldwide impact of COVID-19, but you do not automatically qualify just because you experienced those delays.
As noted above, there are an increasing number of ERTC mills that continue to advertise aggressively and take risky positions that the employers and their CPAs will ultimately have to answer for. Lastly, make sure you are prepared for an audit if you do claim these credits. This program is expected to be targeted by IRS auditors due to the high likelihood of fraud. Employers that legitimately qualify should be certain to take the credit without worry, just be prepared.