‘Supply Chain Provision’ May Extend Employee Retention Tax Credit
Businesses Disrupted by Government Shutdowns Could Qualify
Business owners who experienced supply chain disruptions during 2020 and 2021 due to the COVID-19 pandemic may be able to recoup resulting financial losses through the Employee Retention Tax Credit (ERTC). However, the standards of proof for eligibility are high, requiring extensive documentation.
Created in response to the COVID-19 crisis in 2020, the Employee Retention Tax Credit provided a refundable credit against employee payroll taxes to help businesses cover the cost of keeping workers employed during the pandemic. Though it was in effect only through the end of 2021, it can still be claimed by filing amended quarterly payroll tax returns.
Eligibility for the ERTC typically is determined by a gross receipts test, with the standard of comparison being quarterly receipts in 2020 or 2021 compared to the same quarter in 2019.
Supply Chain Provision
However, under IRS guidance, the ERTC also allows for claims by taxpayers whose businesses were impacted during any calendar quarter in 2020 or 2021 during which they experienced a supply chain disruption caused by a U.S. government order which affected a supplier, causing the supplier to suspend shipment. Under certain circumstances, if the taxpayer can prove the supply chain disruption resulted in economic damage that is traceable to the supply chain disruption, the ERTC may apply.
Government orders may include the closure of ports or business lockdowns that occurred at the height of the pandemic which put shipping companies and manufacturers of raw materials and component parts on hold.
An example of how this could affect a downstream business could be an auto parts manufacturing business called ABC Manufacturing. ABC’s supplier of raw materials was required to fully suspend its operations in 2020 due to a government order. As a result, ABC could not buy raw materials from the supplier and was unable to procure them from an alternate supplier. Because of the suspension of ABC’s supplier, ABC was not able to produce its manufactured goods for a period. Under these facts and circumstances, ABC would be considered eligible for the ERTC during this period because its operations were suspended due to the government order that suspended the operations of its supplier.
No Financial Loss Necessary
Businesses need not show a financial loss during the quarters for which they claim the ERTC under the supply chain provision. They just need to prove that the supply chain disruption caused by a government order rendered them unable to achieve the revenue they had forecasted for that period. They must also provide documentation to directly tie the financial results to the supply chain disruption.
Let’s return to ABC Manufacturing to illustrate this. ABC had introduced a new automotive part to their product line that required a unique piece of molded plastic and had projected sales in 2020 of $3 million in Q3 and $3.7 million in Q4, based on booked orders. But the plastic manufacturer was under a government-ordered lockdown for the first six months of 2020 and was unable to fulfill ABC’s order for the molded plastic parts. Therefore, even though ABC was profitable during those quarters, it is able to show a clear link between the government-ordered lockdown and its loss of sales.
How to Qualify for ERTC Under Supply Chain Provision
To qualify for the ERTC under the supply chain provision, a business must show:
- Suspended shipments or production due to a U.S. government order.
- The business was unable to find an alternative supplier.
- A foreign supplier may have been affected by the shutdown of a U.S. port.
- The quantifiable loss of revenue was a “more than nominal portion” of their business, meaning:
- 10% of the total company revenue.
- 10% of the total company labor hours.
- “Expected” vs. “Actual” performance (2019 vs. 2020 vs. 2021).
Claiming the ERTC for any quarter in 2020 or 2021 requires filing of amended Form 941 payroll tax returns, for which there is a three-year statute of limitations. Given the extraordinary burden of proof and documentation required to claim the ERTC under the supply chain provision, time is of the essence.
If you believe the ERTC may be available to you due to supply chain disruptions in 2020 and/or 2021, contact your Adams Brown advisor for an evaluation.