Certain employers that paid employee wages and/or health insurance premiums during specified portions of 2020 and/or 2021 may be eligible for federal payroll tax-based, fully refundable Employee Retention Credits (ERC).
One of the two circumstances that can make an employer eligible for an ERC is where a trade or business experienced a “Partial Suspension of Business Operations.” A Partial Suspension occurred where a governmental order placed restrictions on the employer’s operations that had more than a nominal effect on those operations (a 10% or greater effect on the employer’s ability to provide the goods or services it normally provides), and where the employer could not conduct comparable operations via telework.
One of the Partial Suspension keys is that the governmental order must have placed restrictions on the operations of the employer’s trade or business. (e.g., Restrictions placed on the employer’s customers do not count for this purpose.) An exception under the IRS’s guidance is where restrictions placed on a critical supplier of the employer’s trade or business, which resulted in a Partial Suspension of the supplier’s operations, can also result in a Partial Suspension for the employer, even though restrictions were not imposed on the employer itself. For this exception to apply, the employer must have been unable to obtain critical goods or materials from its supplier on account of the supplier’s own Partial Suspension, and the employer must not have been able to obtain them from an alternate supplier.
Certain “ERC consultants” have aggressively attempted to expand the application of this narrow exception by taking the position that “supply chain disruption” experienced by an employer may be taken into account as a basis for Partial Suspension purposes.
IRS Chief Counsel Memorandum
On June 30, 2023, the IRS issued a non-precedent Chief Counsel Memorandum (CCM), AM 2023-005, which specifies that “supply chain disruption” alone does not provide a basis for a Partial Suspension.
The CCM also provides five instructive ERC supply-related scenarios. Some important takeaways from the analyses for the scenarios are as follows:
- An employer must be able to demonstrate that a governmental order placed restrictions on its own operations or on the operations of its supplier.
- An employer that was not subject to an applicable governmental order but experienced delays in receiving critical supplies did not have a Partial Suspension if it was able to continue its operations on account of having an existing surplus of those supplies on hand.
- Where needed supplies had arrived at a distribution destination (e.g., a port) but their delivery was delayed due to a truck driver shortage believed by many to be due to COVID-19, the employer did not have a Partial Suspension on account of those delays.
- Continued supply delays caused by a governmental order will not provide for a Partial Suspension period during which wages and health insurance premiums can be counted for ERC purposes after the date as of which the order is lifted.
- Where supplies were unavailable from an employer’s regular supplier, but were available from another supplier for a greater cost, the employer did not have a Partial Suspension.
- Where due to supply chain disruption an employer was only able to stock limited amounts of certain products, and as a result was forced to raise its prices for them, the employer did not have a Partial Suspension, provided it was still able to offer a wide variety of products to its customers.
Final regulations issued impacting ERCs
It is also noteworthy that final Treasury regulations were recently released confirming that an employer that receives a pandemic-related employment tax credit, including an ERC, to which it was not entitled, will be treated as having underpaid its federal payroll taxes in the amount of the denied ERC, with the amount being subject to assessment and administrative collection procedures.
What does CohnReznick think?
CohnReznick has consistently rejected “supply chain disruption” as a basis for an ERC Partial Suspension. We are aware, however, that certain “ERC consultants” have advised their clients that “supply chain disruption” does provide a basis for ERC eligibility. Any employer that based its ERC on the theory of a “supply chain disruption” Partial Suspension should contact its tax advisor for advice as to the possibility of ERC eligibility on a different basis, or how to best attempt to mitigate by refiling with the IRS to return any undeserved ERC amount.
Subject matter expertise
JD, LLM, Managing Director - National Tax Services
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