The IRS released a generic legal advice memorandum, or GLAM, addressing the employee retention credit (ERC) and supply chain disruptions on July 20, 2023. The GLAM discusses five scenarios where taxpayers might qualify for the ERC on the basis of a supply chain disruption, and then it dismisses each of the claims in order. While the specific principles that can be distilled from the GLAM are discussed below, we believe it is telling that the IRS issued a pronouncement on supply chain disruptions and none of the examples discussed in the pronouncement actually qualify under the rule.
The ERC is a fully refundable tax credit for employers impacted by the COVID-19 pandemic. Eligible employers can receive a maximum benefit of $26,000 per employee for wages paid to employees in 2020 (up to $5,000) and in 2021 ($7,000 per eligible quarter, up to $21,000). To qualify for the credit, employers need to have had suffered either a significant decline in gross receipts or a full or partial suspension of their business operations due to a governmental order due to Covid-19. To learn more about the general requirements, check out our ERC flowcharts.
Supply Chain Disruptions
In Q&A #12 of Notice 2021-20, the IRS outlined a path to ERC eligibility based on the concept of a supply chain disruption. For an employer to successfully claim a full or partial suspension due to a governmental order that impacts its supplier, it must meet the following requirements:
- The employer was unable to obtain critical goods or materials from a supplier;
- The supplier was unable to deliver the critical goods or materials due to full or partial suspension of its business due to a governmental order;
- The employer was unable to obtain the critical goods or materials from an alternate supplier; and
- The employer suffered a full or partial suspension of its business due to the inability to obtain the critical goods or materials.
We have always stressed the importance of starting the partial suspension analysis with the relevant governmental orders, and this applies for supply chain disruptions too – focusing solely on the impacts of supply chain disruptions, without more, will not qualify a business. For more info on supply chain disruptions, check out our prior article.
The recent IRS memorandum, AM 2023-005, discusses five scenarios involving supply chain disruptions. Rather than summarize all of them here, we highlight the key principles that can be distilled from the IRS’s analysis of the scenarios:
- There can only be a supply chain disruption if a taxpayer identifies the specific governmental order that fully or partially suspended the supplier’s business. In other words, vague confirmations from the supplier that it was affected by Covid-19 are not enough.
- There is no supply chain disruption if a taxpayer experiences delays in obtaining critical goods or materials, even if it experiences several delays, as long as it had a surplus of goods to operate its businesses. In the words of the IRS, “the relevant inquiry is whether [the employer’s] trade or business operations could continue.”
- The inability to obtain critical goods or materials due to bottlenecks at the U.S. border/port, or due to trucking or shipment delays, does not qualify as a supply chain disruption. Taxpayers need to identify a specific governmental order that suspended the supplier’s business and then demonstrate that the supplier’s inability to deliver the critical goods or materials was caused by the governmental order.
- Even if a taxpayer can demonstrate that a governmental order suspended its supplier’s business and that the taxpayer’s business was suspended as a result of the supplier’s suspension, then the taxpayer can only claim a supply chain disruption for a period of time that is coterminous with the supplier’s suspension period. In other words, delays that continue or occur after the supplier’s suspension period do not qualify as a supply chain disruption.
- There is no supply chain disruption just because critical goods or materials were more expensive than they were before the pandemic; the critical factor is whether the taxpayer was prevented from operating its business. See point #2 above – “the relevant inquiry is whether [the employer’s] trade or business operations could continue.”
- There is no supply chain disruption if a retailer was unable to stock a limited number of products and was forced to raise prices on its other products, as long as it was not prevented from operating its business and had a wide variety of products available to its customers.
Consistent with Q&A #12 that outlined the requirements of a supply chain disruption, the IRS is taking a narrow view of the rule. The release of the GLAM is consistent with the IRS’s various efforts to scale back the ERC. It will be interesting to see how widely IRS auditors apply the GLAM to taxpayers under audit.
If you have questions about the ERC or have received a notice that your ERC claim is being reviewed by the IRS, it is critical that you obtain advice from tax professionals that are steeped in the nuances of the ERC. Withum is and has represented more than 40 clients before the IRS on ERC claims. Our team of dedicated ERC experts can help ensure you get the best outcome possible.