In response to widespread abuse and negligence in the due diligence process related to employee retention credit eligibility (ERC or ERTC) via supply chain disruption, IRS Chief Counsel issued a generic legal advice memorandum that expanded upon the guidance previously discussed in IRS Notice 2021-20.
In the memo, the chief counsel provides several in-depth examples of scenarios in which businesses do not meet the qualifications of government shutdown eligibility through supply chain disruptions despite the businesses having been impacted by supply chain issues. The memo expounds upon the language in Notice 2021-20 to illustrate that a company must be able to show that a supply chain disruption resulted from a government order that suspended its supplier’s business operations. It further reinforces that eligibility ceases upon such orders being rescinded, regardless of whether the supplier continues to experience delays. Any factor contributing to delay not resulting from a government suspension order is not a viable argument for eligibility. At KBKG, we have always acted consistent with the law. However, many other firms gave advice counter to the latest IRS memo.
If supply chain disruption was the basis by which your company took the employee retention credit, we recommend the following:
- Consult with your CPA to ascertain whether there exists sufficient due diligence and documentation to support this position. If a third-party provider was used to calculate the credits, an in-depth analysis of the argument for eligibility presented in their report is essential to confirm whether a frivolous position was taken.
- If it is concluded that a frivolous position was used as the basis of eligibility, identify the credits taken that fall within the erroneous eligibility period.
- Amend the relevant 941x forms to reflect the credit adjustment and return the amount(s) of the refund check(s) to the IRS. Indicate in the notes section that an error was discovered after the initial request for a refund or after information released from the IRS clarified that the company wasn’t entitled to the credit.
- Communicate with your CPA to make sure that any tax returns reflect the changes for deductions so income tax refunds can be requested.
- Suppose fees have been paid to, or a bill has been presented by a third-party provider that based eligibility on a frivolous position. In that case, it may be prudent to contact a legal advisor to discuss recourse for being refunded project fees.
There is substantial risk in not verifying that eligibility for the employee retention credit via supply chain disruption was based on the standards that the IRS outlined in notice 2021-20 and reinforced in the recent memo of the chief counsel. Failure to act could result in a substantial risk of significant penalties and potentially even criminal action, depending on facts and circumstances.