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IRS Issues New Guidance on ERC and Supply Chain Disruptions

August 02, 2023

As the IRS begins stepping up enforcement of ERC claims, they just released a Memo detailing the IRS’ position on the use of supply chain disruptions as a basis for claiming Employee Retention Credits. We have the details here.

Did you claim the Employee Retention Credit (ERC) using a disruption in your supply chain as the basis for your claim? Here’s what you should know if your claim is selected for examination by the IRS.

IRS enforcement efforts -

As we discussed in our recent blog, IRS Sends out Examination Letters about ERC Claims…Here’s What You Should Know, the IRS is stepping up enforcement and reviewing ERC claims possibly due to various ERC mills brashly pressuring ineligible companies to file claims or increasing their already filed claims for the credit.

As we mentioned in our previous blog, the so-called limited commerce or supply chain impact blanket eligibility that is not associated with any specific shutdown order, that certain ERC mills have used to qualify certain companies, is untested under IRS examination. The IRS just released a memo detailing their position on supply chain disruptions which severely narrows the scenarios where an employer would be eligible for the ERC using supply chain disruptions as a basis for their claim.

Key takeaways from the IRS Position Memo –

1. An employer whose supplier was affected by a government shutdown order is not enough to substantiate an ERC claim by the employer.

In order to substantiate the claim, the employer must provide proof of the shutdown order affecting the supplier and substantiate that its operations were impacted by the order.

In the IRS’s example, an employer’s supplier incurred a qualified shutdown order, however the employer had an adequate reserve of critical goods on hand, and the reserve prevented the employer’s operations from being impacted by the supplier’s shutdown order. In this example, the employer would not be eligible for the ERC due to the lack of impact on the employer’s operations.

2. Supply chain disruptions due to bottlenecks at shipping ports must be supported by specific shutdown orders.

Disruptions at shipping ports were well documented during the pandemic. There were many contributing factors, but in most cases, labor shortages of port workers and truck drivers were the main reasons for the bottlenecks at the ports. COVID may have been an indirect cause of the labor shortage, either through infections or employees staying out of the workforce.

However, in order for the bottleneck at the port to be a reasonable basis for an ERC claim, the bottleneck needs to be specifically tied to a government order restricting the operations of the port in question.

In the IRS’s example, an employer’s supply chain was disrupted by a bottleneck at a shipping port where its critical goods are processed due to labor shortages but was unable to identify any specific shutdown orders affecting the port.

In this example, the employer would not be eligible for the ERC since there was not a specific order whereby the port was fully or partially shutdown. Even though COVID most likely was a contributing factor to the labor shortage, an actual shutdown order directly restricting the operations of the port is required for an employer to be eligible to make an ERC claim.

3. ERC claims for supply chain disruptions are limited to wages paid during the order shutdown period only.

When an employer claims ERC, the claim period is limited to the wages paid during the period the shutdown order is in effect. Although the effect of a shutdown order may affect an employer for months or even years, only wages paid during the period during which the shutdown order was in effect are eligible.

4. If an employer was able to obtain critical goods from an alternate supplier, they would be ineligible for ERC, even if the employer incurred higher costs from the alternative supplier.

The IRS notes that “incurring a higher cost for critical goods does not result in a full or partial suspension of operations.”

5. For retailers, unless product shortages caused them to be unable to operate, they would be ineligible for ERC under the basis of supply chain disruptions.

Although many retailers were out of stock or had limited stock of certain goods throughout the pandemic, unless those shortages caused the business to shut down, they would be ineligible for ERC even if their suppliers were directly affected by qualified shutdown orders.

Note - This does not disqualify a retailer from being eligible for ERC in the event they were directly affected by a qualified shutdown order that limited their own business operations during the pandemic.

Is the memo legally enforceable?

While the memo is not legally enforceable, it clearly outlines the position the IRS will take if challenged in court. One cannot predict what the outcome of a potential legal challenge to the IRS’ Office of Chief Counsel’s interpretation will be, however it should be noted by employers that the IRS’ memo is consistent with the original intent of the law.

Any employer taking a position inconsistent with the memo should perform a thorough risk analysis and be prepared to defend their position to the IRS.

Wondering if your ERC supporting documentation is IRS examination ready? We can help. Contact us.

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