Congress acted swiftly during COVID-19 in enacting legislation aimed at incentivizing employers to retain their workforce during the pandemic. Under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), eligible employers who maintained their payroll could qualify for a refundable credit known as the employee retention credit (ERC). To qualify, employers had to meet either a gross-receipts test or a government-order test.
Out of these two tests, the government-order test has proven the most difficult to interpret. The CARES Act provides that an employer meets this test if the company’s business operations were fully or partially suspended due to a COVID-19 government order. Because many employers were not completely shut down but otherwise impacted by COVID-19, the thrust of many pending ERC claims has focused on the meaning of the term partial suspension.
On March 21, 2021, the IRS attempted to provide its own gloss on the term in Notice 2021-20. However, many employers and tax professionals complained that the agency took an overly restrictive view of a partial suspension. And, on May 14, 2024, an Arizona-based company filed a lawsuit against the government, arguing that Notice 2021-20 was unlawful under the Administrative Procedure Act (APA). Although the lawsuit itself is not surprising, a concession made by the government during the course of the proceedings is worthy of attention, particularly for those involved in disputes with the IRS over whether they qualify for the ERC due to a partial suspension.
The Employee Retention Credit
As mentioned above, employers generally qualify for the ERC if they meet either the gross receipts test or the government order test. Under the first test, an employer must show a substantial decline in gross receipts during an applicable COVID-19 employment tax quarter as compared to a pre-COVID-19 tax quarter. Alternatively, an employer may satisfy the second test by showing that its trade or business was fully or partially suspended due to an applicable government order (i.e., an order that limited commerce, travel, or group meetings).
IRS Notice 2021-20
On March 21, 2021, the IRS issued Notice 2021-20. The notice provides the agency’s interpretation of various ERC provisions in a question-and-answer format. Perhaps the most controversial interpretation set forth in the notice relates to the partial suspension prong of the government order test and an employer’s evidentiary burden to show that more than a nominal portion of its business operations were impacted by the government order.
Specifically, Q&A-11 provides that an employer, although an essential business, may qualify under the partial suspension test, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a government order. Later, Q&A-11 clarifies a “nominal portion” to mean that an employer “will be deemed” to meet the nominal portion test if either: (i) the gross receipts from that portion of the business operations is not less than 10% of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or (ii) the hours of service performed by employees in that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).
The Litigation
I have written about the Stenson Tamaddon LLC litigation previously here. In the first dispute, Stenson Tamaddon took issue with the IRS’ moratorium on processing ERC claims that were submitted on or after September 14, 2023. The court resolved that issue in an opinion issued on July 30, 2024. However, Stenson Tamaddon had other claims against the government in its complaint that were not resolved by the July 30, 2024, opinion.
On December 6, 2024, the company moved for summary judgment on these remaining claims. In its summary judgment motion, the company contends that: (i) Notice 2021-20 is unlawful under the APA because the notice serves to implement legislative rules, rather than interpretative rules, and (ii) regardless of the characterization of the rules as legislative or interpretative, Notice 2021-20 violates the APA because it is arbitrary and capricious. You can read more about the APA’s notice-and-comment requirements here.
On January 6, 2025, the government filed its response and a cross motion for summary judgment. Predictably, the government argues that Notice 2021-20 is not subject to the APA’s notice-and-comment procedures because, according to the government, Notice 2021-20 serves solely as interpretative rules. More surprisingly, though, the government makes the following concession to the court regarding the partial suspension test and Notice 2021-20’s commentary on the nominal portion element:
Rather than setting a threshold or a requirement, what the IRS has explained [in Notice 2021-20] is that in its interpretation, partial suspension means something between a full suspension and no suspension. To give taxpayer’s guidance then on how it will evaluate claims for refund, what the IRS has done is establish a framework that taxpayers can rely on. The 10 percent is not determinative for whether an employer has been partially suspended. Instead, if an employer’s business has been partially suspended by a governmental order that has impacted more than 10 percent of its gross receipts or employee hours, the IRS will deem that employer eligible for the ERC. Effectively, this is a safe harbor; taxpayers whose gross receipts or hours have been impacted at that level can rely on the IRS not denying their ERC claim on that basis. Properly understood, it isn’t an eligibility requirement. Even if a taxpayer cannot demonstrate that at least 10 percent of its business has been impacted, it can still be eligible for the ERC if under the ‘facts and circumstances’ the business was partially suspended. The IRS’ interpretation leaves open the real possibility that a business’s operations could have been partially suspended, under the facts and circumstances, even if only suffering, say a six percent reduction in gross receipts. Properly understood, the IRS’s interpretation of the statute provides the taxpayers with the benefits of a safe harbor—it does not impose a threshold or place a limitation on receiving the credit.
Summary
The government’s concession in Stenson Tamaddon is an important development for employers with pending ERC claims. Although the concession was made in pending litigation and not through other IRS guidance, employers should be prepared to raise the issue and cite the government’s motion, especially if the IRS takes a contrary position in denying an ERC claim under the partial suspension test.
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