On July 21, the IRS Office of Chief Counsel released a generic legal advice memorandum (GLAM) concerning eligibility for the ERC due to a supply chain disruption. Though the IRS has cautioned employers to be careful when claiming the ERC and to not claim the credit if they are ineligible, little guidance has been issued illustrating specific situations in which an employer might be ineligible for the credit. In the context of supply chain disruption, the GLAM provides the type of specific guidance taxpayers have been waiting for.
ERC and supply chain disruptions
Generally, an employer might be eligible to claim the ERC if, among other conditions, during 2020 or the first three calendar quarters of 2021 either of the following applied:
- The employer’s business operations were fully or partially suspended by a governmental order due to the COVID-19 pandemic.
- The employer experienced a significant decline in gross receipts during 2020 or the first three quarters of 2021, generally compared to the same calendar quarter in 2019.
Question 12 in the FAQ included in Notice 2021-20 addresses whether an employer may be considered to have a full or partial suspension of operations due to a governmental order if, under the facts and circumstances, all of the following apply:
- The business’s suppliers were unable to make deliveries of critical goods or materials due to a governmental order that caused the supplier to suspend its operations.
- The employer’s business operations were suspended as a result of the inability to obtain the critical goods or materials.
- The employer was unable to obtain the critical goods or materials from an alternate supplier.
The GLAM
The GLAM illustrates the rules of question 12 in Notice 2021-20 using five scenarios with the following key takeaways:
- Vague confirmations from a supplier that shipping delays were due to COVID-19 are insufficient to substantiate ERC eligibility. An employer’s substantiation of ERC eligibility based on supply chain disruption must include identification of the specific governmental order that suspended the supplier’s business.
- Delays in obtaining critical goods, even if due to a governmental order affecting a supplier, do not cause a suspension of the employer’s operations if the employer had a reserve of critical goods to continue its business.
- Merely citing a bottleneck at a port or a truck driver shortage, without identifying the specific governmental order causing the bottleneck or driver shortage, is insufficient to substantiate a full or partial suspension of operations.
- ERC eligibility based on a supply chain disruption is possible only during the time period that a governmental order is in effect. Residual delays after the end of the period covered by a governmental order do not qualify an employer for the ERC.
- Incurring higher costs to obtain critical goods, general product shortages, or having to increase prices on products in limited supply do not qualify an employer for the ERC based on a supply chain disruption if the employer was not prevented from operating its business.
Looking ahead
While the GLAM is informal IRS internal guidance, it provides insight into how narrow the IRS views supply chain disruption and question 12 in Notice 2021-20. The IRS recently announced that it has worked through most of its backlog of ERC claims and is shifting its focus to increase scrutiny on questionable ERC claims, including ramping up its audit and criminal investigation efforts, and is focusing on both promoters and the businesses filing the claims. The GLAM provides insight into one of the areas that could result in denial of an ERC claim. Hopefully, the IRS will provide similar additional guidance to allow employers to better understand its position on ERC eligibility. Employers that are concerned that an already-filed ERC claim might be denied should consult their tax adviser to evaluate the claim and, if necessary, discuss options for how to correct it. Additionally, taxpayers considering filing an ERC claim should consult their tax adviser prior to doing so to determine whether they qualify for the credit.
