More than five years have passed since Congress created the employee retention credit (“ERC”) through the CARES Act. Between then and now, Congress has changed the applicable law four times,[1] and thousands of taxpayers have been embroiled in IRS examinations, appeals, and litigation over their ERC claims. This article is designed to be an informal guide for what taxpayers who are awaiting resolution of their ERC claims should expect. Given the vast array of taxpayers who applied for this credit across the country, and the significant number of my clients who have the same questions about the process, answers to the most frequently asked questions seem to be in order. I’m calling this Frequently Asked Questions (ERC Attorney’s Version) But use caution: IRS FAQs are not legally binding on the IRS or taxpayers, and while I hope this guide is both helpful and correct, it is no substitute for actual legal advice from an attorney who knows the actual facts of your specific case.
Frequently Asked Questions (ERC Attorney’s Version)
All ERC claims will eventually fall into three categories when processed: accepted, denied, or selected for examination. Most of the questions I field from clients center around the examination process, so we start there.
1. EXAMINATION: My company submitted a claim for the ERC and we received a notice of selection for exam. What’s next?
The IRS typically informs taxpayers of an ERC audit via IRS Letter 6612. This letter often attaches a Form 4564, Information Document Request (“IDR”) and usually has a 30-day deadline for response.
- Are we in trouble? What does an examination mean? Selection for examination has little to no bearing on whether a taxpayer has done something wrong or whether the position on the tax return is correct or incorrect. It simply means that the taxpayer has been selected to be examined and that the IRS will review (a) eligibility for the credit, (b) the amount of credit calculated, or both, for certain quarters. Each quarter stands on its own, so it is possible (and we see it all the time) that some quarters are selected for examination while others are not.
- An IRS examination!? Sounds painful and expensive. It just might be, or it might be quick and relatively straightforward. I always tell clients that the more organized and responsive they are, the easier and less costly defending an IRS examination will be. To be sure, claims for small employers will be faster, simpler and cheaper to defend than large employers.
- How long will this take? It depends! Are you organized? Do you have the documents together that establish the basis for eligibility for the credit? Are the people who worked on putting the claim together still working for your organization? If not, is their data readily accessible? We’ve seen IRS examinations on ERC claims take anywhere from six to eighteen months, or longer if the case goes to Appeals (more on Appeals later).
- What should we do after we receive the notice of examination? First thing’s first, retain a tax professional who is authorized to represent you before the IRS. It might be a CPA who helped you prepare the ERC, it might be an attorney, or it might be an Enrolled Agent. Make sure whoever is helping you through this understands both (a) practice before the IRS, and (b) the nuances of defending an ERC claim. Give thought to whether you may want to litigate if your claim is not successful at the IRS, and if so, you may want to start with a litigator now. If not, the person or company that helped prepare your claim may well be best suited to assist you in defending it.
- How should we get ready to respond to the Information Document Request (IDR)? Start collecting documents as soon as possible. The IDRs that the IRS is sending on ERC claims ask for everything, including the proverbial kitchen sink. The IDR puts the burden completely on the taxpayer to establish the entire basis for the ERC claim. This includes both documents that support the basis for the claim and written responses to questions. They are lengthy and request a large set of documents that may take your business weeks to gather. Connect with individuals on your team who have access to various documents like applicable government orders, payroll files, Form 941, Form 941-X, income tax returns, PPP loan documents, etc.
- The Information Document Request is asking me to prove I was eligible, but we don’t meet the gross receipts test. How do we demonstrate eligibility? There are many ways to demonstrate eligibility, but if you don’t meet the gross receipts test, you will need to establish that your business was impacted by government orders. To do this, you should start collecting impact data. Impact data can include financial documents showing a decline in gross receipts, volume data that shows a department’s loss of production, or internal policies that show you adopted measures pursuant to government orders. Many clients think because they don’t meet the gross receipts test that numbers are not important. This is a serious mistake. Numbers can be incredibly helpful to illustrate the way government orders impacted specific service lines. Think back: what are the ways in which my business was most impacted by the government orders in place at the time? One common example we see is when a business had an entire service line either shut down completely or severely limited, such as indoor dining or elective surgeries. Try to think of ways to demonstrate the percentage of revenue generated from service lines such indoor dining prior to COVID, and the change after a government order either prohibited or severely limited indoor dining. Even if a restaurant saw an increase in revenue from more take-out, the decrease in indoor dining may meet a safe harbor threshold to establish eligibility.
- The IDR is asking me to state the basis for my company’s eligibility. What should we say? It is critically important that you work carefully with your tax professional when answering this and any other question that requires a written response. As with any communication with the IRS, your response must be truthful, accurate, and complete. The response to this question will be carefully reviewed when the IRS determines eligibility for the credit, and the importance of getting this right can’t be overstated.
- We can’t possibly respond to this IDR in the amount of time given before the deadline. IDRs have quick turn around times. If you are unable to collect all the requested documents in the prescribed time, make sure to ask the IRS for additional time. Do not let an IDR due date pass without a response to the IRS.
- We found a lot of really helpful data to support the impacts that government orders had on our business after we sent the IDR response. Is it too late to send it to the IRS? As long as the IRS has not formally disallowed your claim, you should always supplement your claim with any helpful information you can. Due to a rule called the “Variance Doctrine,” taxpayers are prevented from making arguments in refund claim litigation that they didn’t raise with the IRS. Out of an abundance of caution, it is always better to support your claim with as many possible reasons why you are entitled to the credit as you possibly can.
- I sent the IDR Response to the IRS. Now what? The IRS can take several weeks to review an IDR response. As the IRS review is underway, continue searching for any responsive documents. Should you find responsive documents, as discussed above, you should supplement that response. Once an IRS examiner has reviewed your IDR response, they may have additional requests for information. The additional requests may be informal (over a phone call) or they could be through a second IDR. It is critical to leave the lines of communication open with the IRS examiner. Either you or the IRS examiner may request a meeting to discuss the documentation provided, determine anywhere the IRS examiner feels they need more information, identify where any disagreements may be, and try to resolve the audit.
- Is there a limit to how many times the IRS can ask for more information? Why do they need all of this? By applying for the Employee Retention Credit, your company asked the IRS to refund employment taxes paid. The IRS is well within its authority to ask for as much information as is needed for you to substantiate the claim. The burden is on taxpayers to establish that they are qualified for the credit. Here’s an important rule of thumb I tell my clients who get frustrated by the IRS asking for something that the client thinks they already have: don’t look a gift horse in the mouth. If the IRS believed that they had enough information to accept your claim, they would have accepted it already. The fact that they are asking you for more, instead of denying the claim, means you are being given an opportunity to demonstrate why you qualify. If you sent it already and they are asking for it, then something about the way we sent it the first time wasn’t compelling enough. Work with your representative to give thought to a more persuasive way to present the data.
- This feels like a lot of work and we don’t think it is worth it. Can my company withdraw the claim? Will we be penalized if we do? Yes, you can withdraw the claim, but the way to do it and whether any additional amount will be due depends on your circumstance. Keep reading for the withdrawal section.
2. DISALLOWANCE: My ERC claim was fully or partially disallowed. Now what?
ERC claims can be disallowed with or without an examination. Your company may receive a full or partial disallowance after hearing nothing from the IRS for years, or on the heels of a very robust examination. Typically, after the IRS has reviewed the claim, it will send a letter proposing adjustments to your return. While this letter can come on various IRS forms or letters, it is often issued on a Letter 525. These letters, commonly referred to as “30-day letters,” give you 30-days from the date of the letter to appeal the proposed adjustment with the Independent Office of Appeals. You may also receive IRS letter 105-C, Disallowance of the Employee Retention Credit or IRS letter 106-C, which is a partial disallowance of the Employee Retention Credit.
- We don’t agree with the IRS full or partial disallowance. What rights do we have? If you do not agree with the IRS determination of what to allow from your ERC claim, you can appeal it by sending a “protest” to the IRS Independent Office of Appeals. As you might imagine, as with anything you are sending to the IRS, there are deadlines for filing a protest, there is magic language that the protest must contain, and there are specific ways in which you must send the protest to the IRS in order for it to be valid. Work carefully with your advisor to make sure this is done correctly, that your deadline is met, and that you have proof of timely filing.
- The Independent Office of Appeals is still part of the IRS. Won’t they just agree with what happened before and rubber stamp the denial? No. In our experience with Appeals both in the years preceding COVID and in processing ERC Appeals, we have found most Appeals officers to be well trained, receptive to hearing the taxpayer’s side, and dedicated to the mission of giving the taxpayer a truly impartial hearing.
- We found a lot of information really helpful for our case, but we didn’t submit it yet. Can I use it in Appeals? Appeals is not permitted to consider new information or arguments not previously considered by the Exam team. However, you can and should submit it. If Appeals determines that it is new information, they will send the case back to Exam for Exam to consider what you send first. If you don’t submit the information or make the arguments you want to make at Appeals, and you did not send it to Exam, you almost certainly won’t be able to rely on it in litigation. As soon as you realize you have additional helpful information, you should send it to the IRS at whatever stage you are in.
- What happens at Appeals? How long does it last? Appeals will consider your protest and ask you to submit any additional information or arguments you have prior to a hearing. Every taxpayer has a right to a hearing at appeals. The hearing can be formal or informal, in-person or virtual. Taxpayers are not required to attend the appeals conference as long as their representative attends, but may want to attend. You should work with your advisor to discuss what your appeals conference should entail. The Appeals Officer will make a determination, and can 1) allow your claim in full, 2) partially allow your claim, or 3) disallow your claim in full. Cases can last anywhere from six to eighteen months at appeals, depending on the complexity of the case.
- I don’t like my result from Appeals. Now what? If your cases has been decided by Appeals and you don’t agree with the result, your only remaining option for resolution is litigation. More on that below.
3. LITIGATION: My company can’t seem to reach an agreement with the IRS. How do we get the ERC funds?
If the IRS has disallowed your company’s ERC claim, “clawed back” a claim previously allowed, or simply failed to respond to your claim, litigation may be your only option to receive payment.
- How do we sue for a refund? Taxpayers who want to enforce a refund claim can sue either in the federal district court where the taxpayer resides or the Court of Federal Claims. The United States Tax Court generally does not have jurisdiction over refund suits. While there are some nuanced ways in which ERC cases can end up in Tax Court, that’s beyond the scope of this article. Unlike in the examination stage, where you can select any representative who is authorized to practice before the Internal Revenue Service, companies that sue to recover a refund must be represented by an attorney and not a CPA or Enrolled Agent. (Companies must be represented by attorneys in federal court and cannot be self-represented). When considering who to hire, make sure you find someone who is well-versed in refund litigation against the Department of Justice and understands the ERC.
- Is there a deadline by which we have to sue? Employers can’t file suit right away after filing a refund claim with the IRS. Instead, all taxpayers have to wait at least six months after a refund claim such as ERC is made with the IRS to file suit. See 26 U.S.C. § 6532(a). After that, if the IRS disallows your claim, you must file suit within two years of disallowance, as is explained above. If the IRS does not disallow your claim, and the six-month waiting period has passed, you can file suit at any time.
- We received a notice of disallowance from Exam, but now we are in Appeals. I don’t want to file a lawsuit against the IRS. As long as I am in Appeals, I don’t have to worry about forfeiting my claim, right? Wrong. It doesn’t matter if you are working cooperatively with Exam, Appeals, or the CEO of the IRS. If you receive a notice of disallowance, you must file suit within two years of the date of the letter or you will forfeit the right to be paid. If you don’t file suit, you must get the IRS to execute Form 907 to extend the time during which you can file suit. More on that here.
- Do I need to pay anything to the IRS to file a refund suit? One of the most important cardinal rules of refund litigation is that a taxpayer must be paid in full in order to pursue refund litigation in federal court. See Flora v. United States, 357 U.S. 63, 68-69, 75 (1958). There are exceptions to this rule, but they are very limited. In the ERC context, however, this rule is not as easily applied. If the IRS disallowed your ERC claim and, therefore, never paid you a refund, you generally do not need to pay anything else; the amount you are seeking is already in the IRS’s pockets. The same thing is true if the IRS never responded to your ERC claim. In other words, you applied for a credit to refund amounts already paid, and you don’t need to pay more to meet the Flora rule. However, if the IRS paid your refund but then clawed it back by making an assessment against you, you may need to file another claim for refund and pay back some portion of the refund to establish jurisdiction in federal court. For employment tax cases, the taxpayer has to, at minimum, pay the tax assessed as to one employee for a single quarter assessment. It is possible that if you have a claw back situation you may be able to go to Tax Court to litigate, but that’s unlikely and requires a lot of procedural steps that are all within the IRS’s control.
- Is it worthwhile to file a refund suit to recover my claim? Litigation is expensive, time-consuming, and can be very stressful for the taxpayer. Exhausting all administrative opportunities to resolve the claim—at Exam or in Appeals—is a best practice. If litigation is the only option left on the table, consider the amount at issue, the merits of the claim, and the potential impact of litigation on ERC claims for other quarters or entities. I always advise my clients to consider not only the cost of litigation in terms of the money spent on attorneys’ fees, but also the opportunity cost to the client. Every minute you spend with an attorney like me preparing the case or sitting in court is a minute you are not running your business.
4. WITHDRAWAL: My company filed an ERC claim but we no longer want to pursue it. Can we withdraw the claim?
The withdrawal process is different for taxpayers who have received their refunds, have not received their refunds, or are currently under IRS examination. This article is written based on current IRS guidance, but that informal guidance is always subject to change. You should always look at the IRS’s most up to date guidance.
- What if I want to withdraw my claim for only one quarter? Withdrawal is quarter specific. It is important to discuss the withdrawal process, and any implications it may have, with counsel.
- What should I keep in mind during the withdrawal process? It is critical to maintain all copies of withdrawal attempts, additional filings, proof of returned checks, and IRS correspondence. Someday you may need to prove you tried to withdrawal.
- How do I withdraw my claim if I have not received my ERC refund? If your claim is not under audit: Follow the specific IRS rules outlined on the IRS website (https://www.irs.gov/newsroom/withdraw-an-employee-retention-credit-erc-claim). If your claim is under audit: Once you are certain that you would like to withdraw your claim, it is important to discuss this with the IRS examiner assigned to your audit. Follow the specific IRS rules outlined on the IRS website (https://www.irs.gov/newsroom/withdraw-an-employee-retention-credit-erc-claim).
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What should I do if I already received the ERC refund I wanted to withdraw? It depends which quarter you want to withdraw and whether and when you cashed the check from the IRS.
- Q1 2020-Q2 2021: If you receive an erroneous refund check from the IRS for Q1 2020-Q2 2021, there is a risk that the government will file suit to recover it, plus interest, for up to two (possibly five) years from the date you deposited the refund check. If you extended the assessment statute, there is also a risk of assessment. The IRS generally has two options to recover an erroneously issued ERC refund: attempt to claw it back administratively through a summary assessment or file an erroneous refund suit. As is explained above, in the absence of an agreement extending the assessment statute, it is too late for the IRS make an assessment for those quarters now. The IRS’s only option to get the money back now is to refer the case to the Department of Justice to file an erroneous refund suit under 26 U.S.C. § 7405.
- Q3-Q4 2021: If you receive an erroneous refund check from the IRS for Q3-Q4 2021, there is a risk that the government will either make an assessment or file suit to recover the refund, plus interest, for many years. If you do not want to take on the risks described above and you have not yet cashed the refund check, follow IRS guidance on how to properly return an ERC refund check: https://www.irs.gov/newsroom/withdraw-an-employee-retention-credit-erc-claim. Please keep in mind that the address to which you mail the paper check may change. If you do not want to take on the risks described above, but you already cashed or deposited the check from the IRS, consider repaying the refund by check: Tax Tip: Returning a Refund, EIP, or Advance Payment of the CTC – TAS.
5. DEADLINES: What are the important deadlines and statutes of limitations to keep in mind?
The Internal Revenue Code is strict in many regards, and deadlines are inflexible. Carefully tracking and meeting important deadlines is critical to ensuring that no rights are waived. There are at least three different statutes of limitations to keep track of: (1) Assessment, (2) Erroneous refund suit, and (3) Refund suit.
- What is the statute of limitations for the IRS to assess additional tax? The IRS has established a mechanism for making administrative summary assessments of tax against taxpayers deemed to have received erroneous ERC refunds. Whether the IRS is within its statutory authority to make such summary assessments is beyond the scope of this article. In general, the IRS’s deadline to make an administrative “summary” determination that you are not entitled to the ERC refund you received and, therefore, you owe a tax debt is determined by Treas. Reg. § 31.3134-1 31.3134-1. The IRS has: until April 15, 2024 to make an assessment for Q1-Q4 2020; and until April 15, 2025 to make an assessment for Q1-Q2 2021. 26 U.S.C. § 6501(b)(2). In the absence of an agreement extending the assessment statute, it is too late for the IRS make an assessment for those quarters now. The IRS has significantly more time to make an assessment for Q3-Q4 2021. The OBBBA extended the assessment statute for these quarters to six years, and, importantly, changed the run-date of the statute to the latest of: (1) the date the original return was filed; (2) the deemed filing date; or (3) the date on which the ERC claim was filed (via Form 941-X). See OBBB sec. 70605(e).
- What is the statute of limitations for the IRS to file an erroneous refund suit? Unlike the summary assessment procedures, the erroneous refund procedures are codified in the Internal Revenue Code and well-established. The Department of Justice’s (“DOJ”) deadline to file a complaint in federal court seeking to recover an erroneously issued ERC refund is governed by 26 U.S.C. § 7405. The DOJ generally has two years from the date the erroneous refund check clears the Federal Reserve to file suit. See 26 U.S.C. § 6532(b); United States v. Page, 116 F.4th 822, 829 (9th Cir. 2024). This statute of limitations is extended to five years if the refund “was induced by fraud or misrepresentation of a material fact.” And if the DOJ does file a timely erroneous refund suit, they are also entitled to the interest that accrued from the date of payment of the refund. See 26 U.S.C. § 6602.
- What is the statute of limitations for taxpayers to sue the IRS? A taxpayer must file suit within two years of the date of mailing a notice of disallowance of their refund claim. See 26 U.S.C. § 6532. As mentioned above, this is the case regardless of whether the taxpayer is appealing the denial at the IRS Independent Office of Appeals. If the IRS never issues a final notice of disallowance, the taxpayer does not have a deadline to file a refund suit. I’m currently litigating a case where the IRS failed to respond to a refund claim for over ten years. Interest accrues to the benefit of the taxpayer that whole time.
Want even more detail? You can take a deep dive into the world of all things ERC behind a paywall in Tax Notes.