Even though the COVID-19 pandemic is now largely in the past, many business owners continue to grapple with the challenges it created—particularly with respect to the government’s response to the crisis. The employee retention credit (ERC) offered a critical lifeline to many businesses that were forced to totally or partially suspend operations in response to the pandemic and responsive government orders. Still, the ERC qualification rules were sometimes confusing, and the program itself was plagued with fraud, delays and other challenges.
Years later, courts continue to interpret the qualification requirements for a successful ERC claim. Last month, a federal court denied the government’s motion to dismiss an employer’s ERC refund suit, possibly handing a significant victory to employers who are still waiting on ERC refunds. For employers struggling to prove they experienced a qualifying partial suspension due to government orders during COVID, the ruling is worth a close look.
See also: What you need to know about the payroll tax suspension
Tri-State Memorial Hospital v. United States: The facts
The key issue in this case was whether the plaintiff had been forced to partially suspend operations due to a government order, as required to claim the ERC.
The plaintiff pointed to a Washington state order that imposed certain COVID-related restrictions on healthcare facilities. They argued that they were forced to partially suspend operations during the first three quarters of 2021 based on multiple factors. Those included being forced to cancel non-urgent procedures, repurpose facilities, implement isolation procedures, reduce capacity and divert staff to perform COVID vaccinations and protocols.
Based on these facts, the facility claimed that its revenue was $4.6 million less than anticipated and filed for an ERC refund. After the government failed to process their refund claim for 16 months, they filed suit. The government responded by filing a motion to dismiss.
In that response, the government claimed that the term “partial suspension” should be interpreted narrowly. They argued that the suspension had to amount to closure of a significant portion of the business, and must extend beyond the basic economic disturbances felt by every business during the COVID era.
The government further argued that the disruptions the plaintiff experienced were not “due to” a government order. Instead, they claimed that it was the COVID virus itself that caused the disruption. Essentially, the government argued for a more stringent “proximate causation” standard, meaning that the order had to be the direct and sole cause of the disruption to qualify under the ERC.
The court’s decision
The court sided with the plaintiffs on both questions in permitting their case to proceed.
First, the court ruled that based on the plain meaning of the term, a partial suspension is a temporary delay, interruption, or termination of an employer’s business. The court agreed that the suspension had to be “more than nominal”. While the court acknowledged that the IRS had previously suggested a 10% standard for satisfying the more-than-nominal standard in Notice 2021-20, the court found that this is not a bright-line test. The 10% threshold is merely one way to prove that the disruption was more than nominal.
With respect to the element of causation, the court determined that a “but for” standard should apply (relying on Supreme Court precedent). That means the employer did not have to prove that the government order was the sole or primary cause of the partial suspension.
Importantly, the court also rejected the government’s argument that it was the virus, not the government order, that caused the disruption. The court accepted the plaintiff’s assertion that they implemented the protocols because of the government’s order, not merely because of the virus itself.
The decision is important because it clarifies that employers are not required to show that a significant portion of their business was shut down entirely to qualify as a partial suspension for ERC purposes. An ERC claim may be based on a temporary disruption or interruption of a more-than-nominal part of the business because of a government order.
Conclusion
It’s important to remember that the Tri-State ruling was resolving a motion to dismiss—not a decision on the merits. When ruling on a motion to dismiss, the court accepts well-pleaded allegations as true and interprets facts as favorably to the plaintiffs as reasonably possible. Now, the plaintiffs in this case will be tasked with returning to court and proving their case with evidence.
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