Section 2301 of the CARES Act, as amended, permits employers to claim employee retention credits (“ERCs”) if they meet certain requirements. Under one of those requirements, an employer may claim an ERC if the employer’s trade or business operations were fully or partially suspended due to a federal or state COVID-19 governmental order (the “Business Suspension Test”).
On March 1, 2021, the IRS issued Notice 2021-20, which provided guidance on the Business Suspension Test. Under that guidance, employers can satisfy the Business Suspension Test if an employer suffers from critical supply-chain disruptions caused by a federal or state COVID-19 governmental order (the “Supply-Chain Test”). Recognizing that some taxpayers have interpreted the Supply-Chain Test broadly, IRS Chief Counsel issued a Generic Legal Advice Memorandum (“GLAM”) on June 30, 2023, which provided IRS Chief Counsel’s interpretation of the Supply-Chain Test through illustrative examples. Summaries of some of those examples and their conclusions of law follow.
Example 1. Employer experienced delays in receiving critical goods from Supplier during 2020 and 2021. Employer had a surplus of critical goods from Supplier and assumed that Supplier’s delay in providing additional goods was due to COVID-19. When Employer questioned Supplier regarding the delay, Supplier vaguely confirmed that the shipping delays were due to COVID-19. However, Supplier did not provide a copy of an applicable government order, and Employer was unable to locate one.
Conclusion. Employer does not meet the Supply-Chain Test because Employer cannot demonstrate a governmental order caused the supply-chain disruption. And, in any event, Employer would not qualify under the Supply-Chain Test regardless because Employer had sufficient critical goods to operate.
Example 2. Employer learned that critical goods it needed from Supplier were stuck at port in State X. Although Employer could not identify a specific governmental order causing the supply disruption, Employer assumed that the bottleneck at the port was caused by COVID-19. Some news sources also suggested the same, but other news sources commented that the bottleneck may have been caused by other factors, such as increases in consumer spending or an aging port infrastructure.
Conclusion. Employer does not meet the Supply-Chain Disruption Test because Employer cannot demonstrate a governmental order caused the disruption of critical goods.
Example 3. During 2020 and 2021, Employer could not obtain critical goods from Supplier. However, Employer was able to obtain the goods from an alternative supplier, albeit at a significantly increased cost to Employer. Employer could continue to operate its trade or business at a reduced profit level due to the increased cost of the critical goods from the alternative supplier.
Conclusion. Employer does not meet the Supply-Chain Disruption test because Employer was not prevented from operating its trade or business at any time in 2020 and 2021. The fact that Employer incurred higher costs for its critical goods, even if due to COVID-19, does not meet the Supply-Chain Test.
GLAMs are not binding or authoritative—stated differently, a federal court may reject the IRS’s interpretation of the Supply-Chain Test in the GLAM. However, the GLAM provides important insight into the IRS’s view of what meets and does not meet the Supply-Chain Test. That is, taxpayers should recognize and expect that these same arguments will be raised by IRS examiners during an ERC audit and, if necessary, in a subsequent challenge in court. Therefore, taxpayers should keep in mind that, to claim the ERC under the IRS’s interpretation of the Supply-Chain Test, they must show, among other things, cause-and-effect—i.e., that a federal or state governmental order caused a critical supply-chain disruption. Taxpayers that cannot point to a governmental order in support of an ERC claim under the Supply-Chain Test can expect their ERCs to be rejected by the IRS under the GLAM guidance and may need to seek relief from the courts.