The IRS has been issuing warnings about claiming the Employee Retention Credit (ERC) for months. In September, they declared a “moratorium” on processing new claims with the stated goal of enhancing the compliance review of ERC claims. One reaction to these ERC warnings has been increased skepticism of the validity of the credit generally and the partial suspension due to government orders eligible employer test in particular.
However, as recently as October 24, 2023, IRS Commissioner Danny Werfel has said, “The ERC is a legitimate credit that has provided a financial lifeline to millions of businesses and exempt organizations.”
As explained in IR-2023-169, the IRS news release announcing the ERC processing moratorium on September 14, 2023, “When properly claimed, the ERC – also referred to as the Employee Retention Tax Credit or ERTC — is a refundable tax credit designed for businesses that continued paying employees during the COVID-19 pandemic while their business operations were fully or partially suspended due to a government order or they had a significant decline in gross receipts during the eligibility periods.” This statement reiterates and summarizes the statutory definition of “eligible employer” which can be met by one of two entirely independent standards. From the CARES Act Section 2301(c)(2) Eligible Employer—
- In General. — The term “eligible employer” means any employer— (i) which was carrying on a trade or business during calendar year 2020, and (ii) with respect to any calendar quarter, for which— (I) The operation of the trade or business described in clause (i) 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 the coronavirus disease 2019 (COVID-19), or (II) such calendar quarter is within the period described in subparagraph (B).
- Significant Decline in Gross Receipts…
Despite recent ERC warnings, a review of communications from the IRS from the time of the moratorium will still find statements supporting the legitimate claims of ERC based on the partial suspension due to government orders test.
The IRS created an interactive checklist meant to help taxpayers determine if they are eligible to claim the ERC. Under Part A, there are a series of questions to check the eligibility of the employer. The first question asks if the employer operated a trade or business and paid employees wages during the applicable period. A “no” answer leads to immediate ineligibility, and “yes” leads to the second question: “Did your trade or business experience the required decline in gross receipts during the eligibility periods in 2020 or the first three calendar quarters (Jan. through Sept.) of 2021?” Here, a “yes” leads to a conclusion that the employer may be eligible, but a “no” leads to the third question: “Are you claiming the ERC because of supply chain issues?” A “yes” to supply chain eligibility leads to a warning to “be extremely cautious,” with some direction to additional resources. However, a “no” answer leads to a fourth question. This fourth question includes three conditions:
“Was the operation of your business or organization fully or partially suspended by a government order due to the COVID-19 pandemic during 2020 or the first three calendar quarters (Jan. through Sept.) of 2021? • The order must be a government order, not guidance, a recommendation or a statement. • The government order must be due to the COVID-19 pandemic and must have fully or partially suspended your operations. • You can only claim ERC for periods the order was in effect and your operations were suspended.”
A ”yes” answer to this fourth question leads to a conclusion that the employer may be eligible:
“If yes, you may be eligible for the ERC. For more information and examples of government orders and full or partial suspension see IRS.gov/ercqualifying. Make sure you have documentation of the government order related to COVID-19, how and when it suspended your operations, and the qualified wages you paid. The IRS will consider your operations to be partially suspended if you can show that more than a nominal portion of your business was suspended by a government order. You can only use wages paid during the period the government order was in effect when calculating your credit.”
Then, there are the recently updated FAQs published about the ERC. Eligibility Question 2 asks, “Who is eligible to claim the Employee Retention Credit?” One eligibility requirement in the answer is that employers must have “Sustained a full or partial suspension of operations due to an order from an appropriate governmental authority limiting commerce, travel or group meetings because of COVID-19 during 2020 or the first three quarters of 2021.”
How much is “partial”?
The most challenging question is how to evaluate when a business was “partially” suspended due to government orders. The statute does not define any quantitative or qualitative measurement for “partially” except to note that the orders must “[limit] commerce, travel, or group meetings (for commercial, social, religious, or other purposes).” None of the Q&As in Notice 2021-20 directly address what it means to be partially suspended. However, one of the new FAQs asks, “What does it mean to be fully or partially suspended?” Unfortunately, the IRS doesn’t really answer this question. First, they answer, “Whether your business or organization was fully or partially suspended depends on your specific situation.” Then, they list three fairly obvious examples of what does not qualify as fully or partially suspended:
“• If all your employees were able to telework during the pandemic and your business continued to operate, your business wasn’t suspended. • If your customers were affected by a stay-at-home order, but no orders applied to your business operations, you weren’t suspended. • If you voluntarily closed your business or reduced hours of operation, you weren’t ordered to suspend.”
An IRS Office of Chief Counsel memorandum Number: AM 2023-007, released on November 3, 2023, summarizes earlier guidance as:
“To fall within the provisions of Section III.D., Q&A 11 of Notice 2021-20, the determination of whether an employer experienced a full or partial suspension of operations depends upon whether more than a nominal portion of an employer’s trade or business operations was suspended by a governmental order or a governmental order had more than a nominal effect on an employer’s trade or business operations.”
This refers to a standard the IRS introduced to measure “partial,” which they call “more than nominal.” The more than nominal standard was introduced in the IRS’ third iteration of ERC FAQs on June 19, 2020. The most recent FAQ, added September 14, 2023, asks, “What does ‘more than nominal’ mean when considering whether my business or organization was partially suspended?” The IRS has delineated two distinct more than nominal suspension types. The first (see Q&A 11 of Notice 2021-20) is where a portion, but not all, of a business was fully suspended, such as the indoor dining portion of a restaurant. In such a case, this more recent FAQ formulation is that “The IRS considers ‘more than nominal’ to be at least 10% of your business based on either the gross receipts from that part of the business or the total hours your employees spent working in that part of the business.” The second type (see Q&A 17-18 of Notice 2021-20) is where all parts of the business could operate, but government-ordered modifications caused a “more than nominal effect” on the business operations. Here, the latest FAQ formulation is, “If all parts of your business could operate but you had to modify how it operated, then we will consider you to be partially suspended if you can show that the order had more than a nominal effect on your business. We consider ‘more than a nominal effect’ to be at least a 10% reduction in your ability to provide goods or services in the normal course of your business.”
It is interesting to note that in another context, taxpayers are subject to an Accuracy-Related Penalty if they substantially understate their income tax liability. The Code defines “substantial understatement” as “10 percent of the tax required to be shown on the return for the taxable year.”
What about “essential” businesses?
In a FAQ added on September 14, the IRS asks, “How does being an essential business affect my eligibility for ERC?” And the answer: “Being an essential business doesn’t necessarily mean you’re ineligible for ERC. You may be eligible based on the gross receipts test, or if you can show that you experienced a partial suspension of operations due to an order from an appropriate governmental authority.”
Should businesses still file legitimate ERC claims during the moratorium?
In a webinar hosted by the IRS on November 2, a representative answered questions from attendees. A video and transcript of the webinar has been made available here. One of the questions was, “Can we still file the ERC claim during the moratorium period? If not, when can we file?” To which the answer was:
“So that and I’m seeing that question come up a lot. And I’m glad that then we got asked. So absolutely, yes, you can submit a claim for ERC during this moratorium. Remember, that the moratorium for any claims are received on or after September 14th, is simply that the IRS is not yet going to process those returns. Right? That’s because we’re urging all the businesses to carefully review to ensure that all the ERC guidelines are met. If you’re 100% confident you know that this is a legitimate and good ERC claim. Please, we then, yes, you should be filing it.”