Reasons Your Business May Not Be Eligible for the Employer Retention Credit (“ERC”) Under a Supplier-Based Partial Suspension or OSHA Position

In a recent press release (click here), Sagemont Tax highlighted common traits to look for to identify possible “ERC mills” that may aggressively be targeting business owners through email marketing, cold calling, and even TV and radio ad campaigns.  Almost all cases of aggressive ERC eligibility positions pushed by ERC mills rely on at least one of two concepts, and often a combination of both: 

1. A supply-chain disruption or impact (the “Supplier-Based Partial Suspension”); or
2. A restriction or modification observed by a business solely under CDC/OSHA (the “OSHA Position”).

While not all Supplier-Based Partial Suspension and OSHA Positions are baseless, we often see that these two concepts are commonly used to stretch eligibility well into 2021, often well after the respective state or local restrictions have lapsed.  

Before we provide a deep dive into the weaknesses that often pervade ERC mills’ boilerplate “impact analyses”, it is important to give credit to the other tax practitioners out there that have publicly flagged and shunned these positions.   It’s clear that the IRS and AICPA have heard the voices of many frustrated CPAs who are tired of their clients being lured by ERC “specialists” that are “innovating” ERC refund positions (or more accurately inventing their own) and it remains to be determined how these arguments will play out in front of an increasingly trained, staffed, and funded IRS.  

Supplier-Based Partial Suspension

A brief history:

To provide additional clarity on what constituted a full or partial suspension of business operations (“FPSO”), the IRS released a series of FAQs as early as June 2020, which gave us the concept of a “Supplier-Based Partial Suspension”: 

“An employer with an essential business may be considered to have a full or partial suspension of operations if 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 essential business’s operations are fully or partially suspended as a result of the inability to obtain critical goods or materials from its suppliers that were required to suspend operations, then the essential business would be considered an Eligible Employer and may be eligible to receive the Employee Retention Credit.”

Remember that when these FAQs were released, most state and local jurisdictions had just emerged from their full shutdown emergency orders where nearly all businesses were categorized as either “essential” or “non-essential”. The IRS had perhaps not yet contemplated that the COVID-19 pandemic, let alone the ERC, might endure three-quarters into 2021.   Hence, when the above words were written, the IRS may have largely been contemplating a period of time when many suppliers or intermediaries in the supply chain had actually been under a full suspension of business operations.  

Fast forward to March of 2021 – he pandemic had spilled into a new calendar year with Congress having already extended the ERC through the Consolidated Appropriations Act (CAA) through Q2 of 2021 and on the precipice of further extending through the remaining year under the American Rescue Plan (ARPA).  On March 1, 2021, the IRS came as close as they were willing to provide authoritative guidance on the ERC by releasing Notice 2021-20.  This Notice blessed the ERC community with, perhaps most importantly, guidance on the PPP-ERC overlap rules (e.g., the no double dipping rules).  However, the Notice also gave us more than 20 pages of more formal guidance on the FPSO test.   Unfortunately, MOST of this guidance was simply a repeat of the series of FAQs that had been built out since the June 2020 FAQs had surfaced.  This included a near word-for-word transcription of the Supplier-Based Partial Suspension: 

“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 they 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.

The Supplier FPSO Fallacy…

We’ve read in many of our competitor’s “impact analyses” and heard from many current and prospective clients the following position: “we were eligible (or told we were eligible) because of a supply chain disruption” (emphasis added).  Often, we see this eligibility stretched all the way through Q3 of 2021. 

Here’s why these positions are generally far too aggressive, or worse, flat-out wrong: 

1. Knowledge of your supplier’s FPSO is necessary – There is nothing in the language cited above that suggests that merely having trouble obtaining goods or materials is sufficient alone to conclude a Supplier-Based Partial Suspension.  In order to determine eligibility under the language above, you must have knowledge that your supplier was shut down.  Inside the “shutdown period” from March 2020 through generally May or June 2020, it might have been possible to have knowledge that your supplier was fully suspended.  However, after the shutdown period, virtually all suppliers in the U.S. could have only been deemed to have met the facts and circumstances eligibility underlying a “partial suspension”.  As most in our industry know, this can be a highly subjective, facts and circumstance-based test (see “How You May be Eligible for the ERC Even Without a Decline in Revenue”).  Hence, only the supplier has or would be in the position to conclude eligibility outside the full shutdown period.  Unless the supplier in question has explicitly represented to its customer that it continued to be under a partial suspension outside the eligibility period, it would generally be impossible for the customer to ascertain eligibility.  
2. The customer’s suspension is seemingly only concurrent to the supplier’s suspension – One of the subtle differences between the FAQs from June 2020 and the Notice guidance in March of 2021 is that the latter references “calendar quarters” when eligibility may be disrupted due to inability to obtain goods or materials from a supplier under a shutdown.   The Notice does not suggest that lingering supply chain disruptions into late 2021 that were a result of supplier shutdowns in prior periods would qualify the customers under this test.  Therefore, the best and safest interpretation of the language chosen by the IRS is that a customer can only experience an FPSO based on a supplier disruption while the supplier is also under a partial suspension.  While perhaps the most “open to interpretation” of the three based on the IRS’ use of past tense in “because they were required to suspend operations”, the third fallacy often trumps points #1 and #2 (though we would contest the liberal interpretation of the meaning of the word “were” here).  
3. The supply chain disruption must still rise to a more than nominal threshold. By definition, a customer seeking to make a Supplier-Based Partial Suspension argument would only be doing so under the concept of a “partial suspension”, not a “full suspension”; Therefore, the general standard of meeting a “more than nominal effect” threshold must be met.  This is a facts-and circumstances-based test with a slightly convoluted safe harbor that looks at whether restrictions or modifications inhibit a business’s ability to provide goods or perform services by more than 10%.  Therefore, not only would a customer need to be aware that this threshold has been met for their supplier outside the shutdown period, but a customer would also need to self-assess that the supplier’s partial suspension was meaningful enough to meet the more-than-nominal-effect threshold for such customer.  Suffice it to say that for a significant majority of customers operating in the post-shutdown world, this would be a very hard standard to meet and substantiate in front of the IRS in the case of a challenge.  

After considering the above, it may be helpful to remember that the IRS “invented” the concept of a supplier-based suspension on or before June 2020, when the U.S. industries had just started barely operating again.  

The OSHA Position 

Governmental Mandate Requirement

Under the ERC, the following language was used to define “governmental orders”: 

Orders, proclamations, or decrees from the Federal government or any State or local government may be taken into account by an employer as “orders from an appropriate governmental authority” only if they limit “commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to the coronavirus disease 2019 (COVID-19)” and relate to the suspension of an employer’s operation of its trade or business.  Orders that are not from the Federal government must be from a State or local government that has jurisdiction over the employer’s operations.

Perhaps the most important words to focus on above are “due to the coronavirus disease”, through which it can be inferred that order, proclamations, and decrees, in place prior to the COVID-19 crisis may not constitute governmental orders.  

Further, it can be inferred through other examples that guidelines followed pursuant to the Center for Disease Control and Prevention (CDC) recommendations and the Department of Homeland Security (DHS) guidance are not qualifying governmental orders.  

Why the ‘general duty clause’ is NOT a warm eligibility blanket…

OSHA’s “general duty clause”, which has been cited time and time again by ERC mills as a qualifying governmental order, was enacted in 1970, significantly predating the COVID-19 pandemic.  Furthermore, OSHA’s standards are generally applicable to the entire economy and are commonly understood to be guidelines, similar to those of CDC and DHS.  It is also commonly agreed upon by ERC subject matter experts from some of the top law and accounting firms across the U.S., and also by many of us “smaller” players, that the government mandate test was not meant to capture every single business in the United States in terms of applicability. Therefore, it would seem logical to conclude that OSHA standards do not blanketly result in all businesses in the U.S. being deemed to be under governmental order throughout the entirety of the potential ERC eligibility period (which spans from March 13, 2020 through September 30, 2021). 

Notwithstanding the above, Sagemont Tax does agree that certain businesses either were in (i) geographies where the state/local order(s) mandated adherence to the OSHA general duty clause, or (ii) industries, such as healthcare, that were subject to regulatory requirements that were intertwined with CDC and OSHA restrictions and modifications, and therefore may still take an OSHA position, provided other “tests” are met.   

My supplier was subject to OSHA! 

The holy grail of achieving ERC eligibility by ERC mills has been to couple the Supplier-Based Partial Suspension with the OSHA Position.  In nearly all states, including California and New York, social distancing requirements had lapsed by July 1, 2021, which marks the first day of the last potential ERC quarter for businesses (other than “recovery start-up businesses”).  It also marks the start of the first quarter (Q3 and Q4 2021) which is subject to the extra two years of statute of limitations given to the IRS under ARPA.   Thus, one would think it would be surprising that this is perhaps the most abused quarter in terms of evaluating eligibility by ERC “pop-up shops.”  

Unfortunately, by coupling the Supplier-Based Partial Suspension with the OSHA Position, we’ve seen many firms create enough “smoke and mirrors” around the eligibility test to confuse their clients into thinking that any type of supplier disruption can create ERC eligibility.  This includes not only situations where there is an inability to actually procure goods or materials, but we’ve even seen firms suggest that increases in prices of supplies could be a qualifying fact pattern.   All that to say, for the most part, the positions are at best impossible to substantiate. 

Final Thoughts

The ERC has -and continues to be – a godsend for small businesses throughout the United States. With inflation rising across the nation, government funding from the CARES Act continues to save businesses from shutting their doors. With up to $26,000 in refundable tax credits per W-2 employee, an appropriate ERC claim can be significant for your business. 

If there’s one thing the PPP experience has shown this country, it’s that the federal government takes the improper claim over stimulus funds VERY seriously and is not afraid to prosecute those who have abused the system, which can include both end-recipients and third-party providers.  Sagemont Tax continues to urge employers to be wary of ERC mills promising full eligibility with little substantiation, particularly those using Supplier-Based Partial Suspension with the OSHA Position.  Other weak arguments may include an overemphasis on trade show restrictions, face mask mandates, work-from-home transition, and intermittent COVID-19 outbreaks.  We would encourage any business owner taking an ERC position that is not deeply seated in social distancing, enhanced sanitation and hygiene procedures, or alterations to the change in format of their service, to exercise heightened care and discretion in pursuing a claim.  If you or someone you know are claiming ERC, or intend to claim the ERC, please make sure to understand who is performing your work, what they are claiming, and what you are expected to get in return.

To that end, to learn more about the advantages of working with Sagemont Tax over ERC mills and other ERC competitors, please visit our “Sagemont Tax Advantages” page HERE.