On Friday, July 21, the IRS release a Chief Council Memorandum on the subject of whether or not a business qualifies for the employee retention credit (ERC) based on supply chain disruptions. Here is a link to the memorandum: https://www.irs.gov/pub/lanoa/am-2023-005.pdf
The short answer is, no, a supply chain disruption does not qualify a business for ERC.
The memo analyzes five scenarios.
Scenario 1
Here is Scenario 1 from the memo:
Employer A was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, during 2020 and 2021, Employer A experienced several delays in receiving critical goods from Supplier 1. At all times during 2020 and 2021, Employer A continued to operate because Employer A had a surplus of the critical goods normally provided by Supplier 1. Employer A assumed that Supplier 1’s delay in delivering critical goods was caused by COVID-19. Employer A inquired and Supplier 1 vaguely confirmed that the delay was due to COVID-19. Supplier 1 did not provide a governmental order from an appropriate governmental authority and Employer A was unable to locate one.
The IRS’s analysis here is that the business does NOT qualify for ERC. The supplier was not shut down, and mere “disruptions” in the delivery of goods does not count.
Here’s another point for thought: the IRS goes on to say that, even if the supplier did have a shutdown order in place, Employer A had enough goods on hand to operate normally:
Even if Employer A received or could locate the governmental orders applicable to Supplier 1, Employer A did not have to cease operations because Employer A had a reserve of critical goods allowing Employer A to continue operations; thus, Employer A did not experience a full or partial suspension of operations due to an inability to obtain Supplier 1’s critical goods. The relevant inquiry is whether Employer A’s trade or business operations could continue; since Employer A was able to continue its own business operations despite the supply chain disruption, it was not subject to a full or partial suspension of operations.
So the qualifier of “a business qualifies if essential supplies were shut down” has a caveat: the business only qualifies if the shutdown of suppliers caused a disruption to the business.
Scenario 2
Per the IRS scenario:
Employer B was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, certain critical goods from Supplier 2 were stuck at port in State X. Employer B assumed the bottleneck at the port was a result of COVID-19. Employer B could not identify any specific governmental order applicable to Supplier 2 or any specific governmental order that caused the bottleneck at the port. Some news sources stated that COVID-19 was the reason for the bottleneck, while others cited reasons such as increases in consumer spending and aging infrastructure. In addition, Supplier 2 mentioned to Employer B that other critical goods that were not stuck at port would be delayed due to a truck driver shortage. Employer B saw some discussion on social media that the truck driver shortage was because drivers were out sick due to COVID-19.
The analysis here is the same as in Scenario 1 — this business does not qualify. No “government orders” caused the delays. It may be true that COVID caused the delays, but the requirement for ERC qualification is that it must be a “government order.”
Scenario 3
Per the IRS scenario:
Employer C and Supplier 3 are located in a jurisdiction that issued governmental orders suspending both of their business operations for the duration of April 2020. Employer C and Supplier 3’s jurisdiction lifted all orders related to COVID in May 2020. For the remainder of 2020 and 2021, Employer C experienced a delay in receiving critical goods from Supplier 3. Supplier 3 does not provide a reason for the delay, but Employer C assumes the delay is due to the governmental order in place in April 2020.
In this scenario, Employer C qualifies during the time period the written shutdown order was in place (April of 2020). It does not qualify later, even if delays could possibly be tied back to the government order — the order itself expired after April of 2020, and so ERC qualification expires then too.
Scenario 4
Per the IRS scenario:
Employer D was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. During 2020 and 2021, Employer D could not obtain critical goods from Supplier 4. However, Employer D was able to obtain the goods from an alternate supplier. The critical goods from the alternate supplier cost 35% more than those from Supplier 4. Employer D could continue to operate its trade or business even though it was not as profitable as in 2019.
The IRS says this business does not qualify for ERC. There were no government orders in place against the business, or its suppliers. (NOTE: the scenario does not say why the business couldn’t obtain supplies from “Supplier 4.”) Per the IRS, the mere fact that the goods from the alternate supplier cost more is NOT a qualifier for ERC.
Scenario 5
The fifth and final scenario in the memo:
Employer E operates a large retail business selling a wide variety of products. Employer E was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 in 2021. Due to various supply chain disruptions, Employer E was not able to stock a limited number of products and was forced to raise prices on other products that were in limited supply. However, at no time did the product shortage prevent Employer E from continuing to fully operate as a retail business during 2021.
The IRS says this business does not qualify for ERC. There were no written shutdown orders against the business, or against its suppliers.
Conclusion
This memo tracks along with what I have said regarding shutdowns and supply chain issues. If a business can show that an essential supplier was shut down by written government order, and it had an impact on operations then the business likely qualifies. Mere “disruptions” due to COVID do not qualify.
Note that Chief Counsel Memoranda are not authoritative guidance and cannot be cited or used as precedent; however they provide a window into the IRS’s views on various topics.