New IRS Guidance on ERC & Supply Chain Disruptions

On July 20, 2023, the Internal Revenue Service (IRS) released Chief Counsel Advice Memorandum AM 2023-005, which provides further guidance for determining if an employer qualifies for the Employee Retention Credit (ERC) through a full or partial suspension of operations due to a supply chain disruption. While the language in the CARES Act and the tax code does not explicitly include supply chain disruptions as a qualifying event, Notice 2021-20 provides a limited example of an employer qualifying for the ERC due to an interruption of critical supplies.

The primary topics addressed in this Advice Memorandum include whether a supply chain disruption satisfies the full or partial suspension of operations test to claim the ERC and what documentation is needed to substantiate a supply chain disruption claim. Any claim on whether an employer met the full or partial suspension of operations test must start with an appropriate federal, state, or local government order. Based on previous guidance in Notice 2021-20, as well as the analysis provided in AM 2023-005, this requirement can extend to supply chain disruptions in certain instances. However, this does not serve as a catch-all for businesses impacted by the supply chain.

When determining whether a supply chain disruption constituted a suspension of operations, the guidance states that the supplier of critical goods must have been subject to a government order that suspended its own operations. This will likely prove challenging to most employers as most manufacturers and suppliers were declared essential businesses in their respective states and allowed to continue operations throughout the pandemic. In addition, it can be difficult to definitively establish why a supplier cannot deliver critical goods to an employer without the entire picture of the supplier’s operations.

The IRS has identified fraudulent ERC claims as the number one issue on their annual Dirty Dozen list, as many unscrupulous providers are stretching the facts of qualifying criteria. With the high number of erroneous and fraudulent ERC claims being made, the IRS is likely to examine many of these, including those using supply chain disruptions as the cornerstone of their eligibility.

When looking to justify a suspension of operations due to supply chain disruptions, taxpayers need to build their argument on the applicable federal, state, or local government orders that impacted their suppliers and gather additional documentation from the supplier to support this position.

If you have any questions about the Employee Retention Credit, please do not hesitate to reach out to us.