A federal court has issued a significant ruling against Employee Retention Credit claims grounded in supply chain disruption. In Sevillo Fine Foods v. United States, the court rejected the argument that port congestion and upstream supplier shutdowns qualified a business for the ERC under the partial suspension test. The decision has direct implications for retail and CPG operators who filed ERC claims based on sourcing problems rather than a direct government order shutting down their own operations.
Quick Refresher: The ERC and the Partial Suspension Test
The Employee Retention Credit was available to employers whose operations were fully or partially suspended due to a governmental order limiting commerce, travel, or group meetings. Many businesses that stayed open during 2020 and 2021 but faced supply disruptions argued they were partially suspended because their suppliers were subject to shutdown orders, which prevented them from obtaining the goods or ingredients they needed to operate normally.
The IRS issued guidance in Notice 2021-20 acknowledging a supply chain theory but set a high bar: the supplier itself had to be subject to a government order that suspended its operations, and that suspension had to have a direct effect on the taxpayer’s ability to operate. Indirect or attenuated effects were not enough.
What Happened in Sevillo Fine Foods
Sevillo Fine Foods is a food manufacturer that argued it was partially suspended because port congestion during the pandemic delayed the delivery of ingredients sourced from overseas suppliers. The company built a six-step causal chain from government health orders to port operations to shipping delays to ingredient shortages to its own reduced production.
The court rejected this theory on several grounds:
The causal chain was too attenuated. A six-step sequence between a government order and the taxpayer’s operations does not satisfy the requirement of a direct governmental order limiting the taxpayer’s own commerce.
Advisory directives are not binding orders. The court distinguished between mandatory government orders that actually suspended operations and advisory or recommendatory guidance that did not legally compel any business to shut down. Port operations continued under health protocols, they were not ordered closed.
Operational slowdowns are not partial suspensions. Higher costs, longer lead times, and reduced throughput caused by market conditions, even conditions traceable back to pandemic policy, are not the same as a governmental order limiting commerce. The statute requires an order, not an economic consequence.
The taxpayer’s financial results were inconsistent with the claim. The court noted an internal inconsistency between the company’s claim of a significant operational suspension and its reported financial performance during the same quarters, which the court found undermined the credibility of the suspension theory.
The court also denied the taxpayer’s request to amend its complaint and entered a final order against the ERC claim.
Why This Matters for Retail and CPG Operators
A large number of retail and CPG businesses filed ERC claims under some version of the supply chain theory. Common fact patterns in this industry included:
Ingredient or raw material shortages caused by overseas factory closures. Port delays on imported goods from Asia, particularly for CPG brands sourcing packaging or product components. Supplier warehouse shutdowns that delayed fulfillment of purchase orders. Retail store operators who stayed open but experienced inventory disruptions from closed distribution centers.
Many of these claims were filed based on professional advice that the IRS supply chain framework in Notice 2021-20 supported the position. The Sevillo decision signals that courts are not sympathetic to indirect or multi-step causal theories, even where the supply disruption was real and significant.
What Still Qualifies
Businesses that were subject to direct government orders limiting their own operations remain on solid ground. This includes retailers that were ordered to close or limit capacity by state or local health orders during 2020 and 2021, restaurants limited to outdoor or delivery only, venues prohibited from holding group events, and businesses in states with explicit sector-specific closure mandates.
The key distinction is direct versus indirect. If a government order named your business or your industry and required you to close or significantly curtail operations, the ERC claim is defensible. If your connection to a government order runs through a supplier, a port, or a logistics network, Sevillo makes that claim substantially harder to sustain.
Bottom Line: Sevillo Fine Foods is a significant loss for businesses that claimed the ERC based on supply chain disruption rather than a direct government order. If you received the credit on that basis, now is the time to assess your exposure and explore resolution options before the IRS makes contact.