Employers Can't Rely on Supply Chain Disruptions to Claim Employee Retention Credit

(Parker Tax Publishing August 2023)

The Office of Chief Counsel advised that, for purposes of determining an employer's eligibility for the employee retention credit under Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. 116-136) and Code Sec. 3134, an employer is not an "eligible employer" solely as a result of supply chain disruptions. The Chief Counsel's Office explained that a narrow, limited exception applies under Notice 2021-20 for employers that had to fully or partially suspend their business operations because their suppliers who provided critical goods or materials were fully or partially suspended due to orders from a governmental authority. AM 2023-005.

Background

The Office of Chief Counsel was asked whether, under the scenarios involving supply chain disruptions described below, the operation of an employer's trade or business was fully or partially suspended during a calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 (i.e., the "suspension test") such that the employer satisfies the definition of an "eligible employer" under Section 2301(c)(2)(A)(ii)(I) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. 116-136) and Code Sec. 3134(c)(2)(A)(ii)(I).

Section 2301(a) of the CARES Act, as amended by Section 206 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), enacted as part of the Consolidated Appropriations Act, 2021 (Pub. L. 116-260), provides an employee retention credit for "eligible employers" subject to closure due to COVID-19. The credit provided under the CARES Act is generally allowed against applicable employment taxes for 50 percent of the qualified wages paid after March 12, 2020, and before January 1, 2021. Section 207 of the Relief Act increased the credit to 70 percent of qualified wages paid for the first and second quarters in 2021. The American Rescue Plan Act of 2021 (Pub. L. 117-2) enacted Code Sec. 3134, which provides a substantially similar employee retention credit for wages paid after June 30, 2021, and before October 1, 2021.

Section 2301(c)(2)(A)(ii)(I) of the CARES Act and Code Sec. 3134(c)(2)(a)(ii)(I) define the term "eligible employer," in part, as any employer whose trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19. In Notice 2021-20, the IRS provided specific guidance regarding orders from an appropriate governmental authority as well as when the operation of an employer's trade or business is considered fully or partially suspended. Section III.D., Q&A 12 of Notice 2021-20 provides that 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, the business's suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations. If the facts and circumstances indicate that the business's operations are fully or partially suspended as a result of the inability to obtain critical goods or materials from its suppliers because the suppliers were required to suspend operations, then the business would be considered an eligible employer for calendar quarters during which its operations are fully or partially suspended and may be eligible to receive the employee retention credit.

In Scenario 1, 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.

In Scenario 2, 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.

In Scenario 3, 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 Scenario 4, 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 percent 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.

In Scenario 5, 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.

Analysis

The Chief Counsel's Office advised that a supply chain disruption, by itself, does not rise to the level of a full or partial suspension primarily because no governmental order applies to the employer's operations. The Chief Counsel's Office noted that the language of Section 2301(c)(2)(A)(ii)(I) of the CARES Act and Code Sec. 3134(c)(2)(A)(ii)(I) does not include supply chain disruptions. Instead, Section III.D., Q&A 12 of Notice 2021-20 provides a narrow, limited exception for employers that had to fully or partially suspend their business operations because the employers' suppliers who provided critical goods or materials to the employer were fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority. According to the Chief Counsel's Office, Notice 2021-20 allows the employer to "step into the shoes" of its supplier for purposes of the suspension test. To meet the terms of this exception, as explained in Q/A-12, the supplier must have been subject to a governmental order that causes the supplier to suspend its operations.

The Chief Counsel's Office advised that in Scenario 1, Employer A does not meet the definition of eligible employer because it cannot demonstrate that a governmental order applicable to Supplier 1 fully or partially suspended Supplier 1's trade or business operations. Even if Employer A received or could locate the governmental orders applicable to Supplier 1, Employer A did not have to cease operations because it had a reserve of critical goods allowing it 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, according to the Chief Counsel's Office, 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.

In Scenario 2, Employer B does not meet the definition of an eligible employer, the Chief Counsel's Office advised, because it cannot demonstrate that a governmental order applicable to Supplier 2 fully or partially suspended Supplier 2's trade or business operations. In addition, while COVID-19 may have been a contributing factor to the bottleneck at the port or the truck driver shortage, Employer B could not substantiate that any specific governmental order caused a bottleneck at the port.

The Chief Counsel's Office found that in Scenario 3, Employer C is an eligible employer in the second calendar quarter of 2020 because its business operations were fully or partially suspended due to a governmental order. However, only wages paid with respect to the period during which Employer C is fully or partially suspended due to a governmental order may be considered qualified wages. The Chief Counsel's Office said that Employer C does not meet the definition of an eligible employer for any subsequent calendar quarter in 2020 or 2021 because it cannot demonstrate that a governmental order applicable to Supplier 3 fully or partially suspended Supplier 3's trade or business operations. The residual delays caused by a governmental order in place during a prior calendar quarter, the Chief Counsel's Office advised, will not constitute a governmental order in subsequent calendar quarters once the order has been lifted.

In Scenario 4, Employer D does not meet the definition of an eligible employer, according to the Chief Counsel's Office, because Employer D could continue to operate its trade or business. The Chief Counsel's Office noted that Employer D was not prevented from operating its trade or business at any point during 2020 or 2021. Incurring a higher cost for critical goods, the Chief Counsel's Office said, does not result in a full or partial suspension of operations.

The Chief Counsel's Office advised that in Scenario 5, Employer E does not meet the definition of an eligible employer during calendar year 2021 because it cannot demonstrate that a governmental order applicable to a supplier of critical goods or materials caused the supplier to suspend operations and that Employer E was unable to obtain critical goods and materials causing a full or partial suspension of Employer E's business operations. At all points during 2021, Employer E was able to operate its retail business. While a limited number of products were not available, Employer E was still able to offer a wide variety of products to its customers and Employer E was not forced to partially suspend operations.

For a discussion of the eligibility rules for the employee retention credit, see Parker Tax ¶106,460.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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