New IRS Guidance Highlights the Importance of Substantiation for ERC Claims

The Employer Retention Credit (“ERC”) was one of the biggest relief programs created for employers during COVID-19. Most eligible employers could claim up to $26,000 per employee kept on payroll for the last three quarters of 2020 and the first three quarters of 2021. The IRS previously issued guidance on the ERC under Notice 2021-10; and has now released further clarification with AM-2023-005 for certain situations.

The memo addresses five different scenarios. In each scenario, the employers were generally not subject to government shutdown orders directly, but experienced delays in receiving goods from suppliers during 2020 and 2021. In each scenario, the employer was unable to provide a governmental order showing that their supplier was required to suspend its operations for the quarter(s) in question.

Of particular note are Scenarios 2 and 3 in the guidance. Scenario 2 addresses the supply chain bottlenecks that occurred at ports and points of entry during the height of the pandemic and concludes that even if an employer can show that a government order was “applicable” to a supply chain bottleneck, they must still show that the bottleneck was “due to” the order. Scenario 3 differs from the others in that it addresses residual delays caused by previous governmental orders, with the conclusion that residual delays from government orders after they have been lifted do not make an employer eligible, even if the supplier was forced to suspend their operations.

While none of the outcomes of the scenarios are surprising, the memo shows that the IRS will be scrutinizing claims of partial shutdowns carefully. Employers cannot rely on assumptions, hearsay, or assurances from others that their supplier shutdown was due to a government order. It also highlights that employers need to fully understand the requirements for qualifying under a full or partial shutdown; as it seems many employers believe that as long as the shutdown was “caused by COVID,” they are eligible. The IRS recently added the ERC to its “Dirty Dozen” list and it is under increased scrutiny, so employers seeking to claim the Employee Retention Credit should be sure to engage a trusted tax professional to advise them on their eligibility.