The IRS recently released a Generic Legal Advice Memorandum (GLAM 2023-005) addressing the potential impact of supply chain disruptions on an employer’s eligibility for the employee retention credit (ERC).
An employer may be eligible for the ERC if it satisfies, among other conditions, one of the following two eligibility tests during an applicable calendar quarter (generally in 2020 or the first three quarters of 2021):
- The employer’s business operations were fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 (the “suspension test”)
- The employer experienced a significant decline in gross receipts (generally as compared to the same calendar quarter in 2019)
For purposes of the suspension test, the IRS previously issued guidance in Notice 2021-20 (Q&A-12) which provides that an employer not subject to a government suspension order may still be considered to have a full or partial suspension of business 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 (the “supplier suspension rule”).
In the GLAM, the IRS addressed the application of the supplier suspension rule to five different scenarios involving various supply chain disruptions, including one involving a particular supplier’s goods being stuck in a port due to various reasons other than a specific governmental order (e.g., increased consumer spending, aging infrastructure, truck driver shortage).
The IRS explained in the GLAM that the supplier suspension rule was intended to provide a narrow, limited exception for employers that had to suspend their business operations, fully or partially, because the employer’s suppliers that provided critical goods or materials were fully or partially suspended due to orders from an appropriate governmental authority. A supply chain disruption, by itself, would not rise to the level of a full or partial suspension because no governmental order applies to the employer’s operations. The supplier suspension rule allows the employer to “step into the shoes” of its supplier for purposes of the suspension test, and therefore, the rule would only apply if the supplier was subject to a governmental order that caused the supplier to suspend its operations.
The IRS also indicated that, in addition to having a governmental order, an employer must substantiate its eligibility for the credit by providing records or documentation demonstrating all of the following:
- The governmental order caused the supplier to suspend operations
- The inability to obtain the supplier’s goods or materials caused a full or partial suspension of the employer’s business operations
- The employer was not able to obtain the critical goods or materials from an alternate supplier
The IRS ultimately concluded that the employer was not an eligible employer under the suspension test in four of the five scenarios, generally because the employer could not demonstrate that a specific governmental order required either the employer or supplier to suspend its operations (even though there were other types of supply chain disruptions). In the one scenario where the IRS found the employer was eligible under the suspension test, both the employer and supplier were subject to specific governmental orders that required suspensions of their business operations for part of a calendar quarter in 2020. However, the IRS also concluded that the required suspensions ended when the orders were lifted even though the supplier continued to experience residual delays in the subsequent calendar quarter.
A GLAM is informal guidance that is not binding on either the IRS or taxpayers (and cannot be used or cited as precedent), but it can provide insight into the IRS’s current thinking on a particular matter. Employers should consider this guidance when determining or documenting eligibility for the ERC under the suspension test.
The IRS has made enforcement of employee retention credit claims a major compliance focus and IRS Commissioner Danny Werfel recently told Congress that the IRS would support legislation providing an end date for filing claims and giving it more oversight of paid preparers.
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