The holidays – and the Internal Revenue Service (IRS) – brought businesses that claimed the Employee Retention Credit (ERC) some very good news. It was not that long ago that the IRS was claiming that the ERC program was rife with fraud. IRS Commissioner Danny Werfel was quoted as recently as March 2024 as estimating that “19 out of every 20 claims is suspect.” Thankfully, the environment has improved quite a lot over the last several months.
In June, the agency reported that 10-20% of the ERC refund claims that it had held up for further review were actually “low risk” – not great, but better than the 5% validity rate Commissioner Werfel had implied only a few months prior. The percentage of claims that are low risk seems to be growing by the day. In October, the agency said it would process 400,000 of the still pending ERC refund claims, “with the vast majority in this tranche being processed for approval.” The IRS had about 1.2 million claims unprocessed claims in October, according to a recent report by the National Taxpayer Advocate, so that works out to an approval rate of about 30%, factoring in that some claims will be denied. Most recently, in mid-December, the IRS Commissioner said that the agency would approve 500,000 ERC claims in 2024 and another 500,000 to 600,000 in 2025. That is an approval rate of approximately 90% and represents a dramatic turn in favor of taxpayers.
In this article I share some thoughts about what taxpayers should consider doing when: 1) the IRS has not yet acted on a refund claim, 2) the IRS has denied an ERC refund claim, 3) the IRS has issued a dreaded “recapture” letter for an ERC refund that the IRS now believes may have been paid in error or 4) the IRS’ repeated warnings about fraud caused a taxpayer who might be eligible to not file a claim at all.
What to Do with Pending ERC Refund Claims
In most cases, the best course of action if the IRS has not yet acted on your ERC refund claims is to wait for the IRS to complete its review. I know most small employers do not want to hear that, but the IRS has now said it is going to grant the vast majority of pending refund claims. Moreover, the IRS is currently paying 7% interest on claims that eventually are approved, which is a generous return when you consider that the payment is backed by the U.S. government.
How long will you have to wait? It’s impossible to say for sure in any specific case or even anticipate how the IRS will decide to allocate resources to ERC refund claims generally, but I expect that most of the IRS’ attention over the next several months will be on processing incoming tax returns, which is the agency’s principal mandate. My best guess is that the IRS’ immediate focus on incoming returns means that it pays ERC refunds sporadically throughout the spring with a significant uptick beginning in May on the backside of “filing season”. You can check your IRS account for activity that may precede an actual refund by several weeks.
What if you can’t wait any longer? The only way to force the IRS to act more quickly is to sue in federal court, which can make sense when the size of the claim justifies the expense. I have previously written about what you should consider before suing the IRS for an ERC refund here. In a nutshell, the upside to litigation is that it will give you some certainty on timing as the case will be put on a court schedule. But the increased certainty on timing carries litigation risk and costs you attorney fees. As to litigation risk, the case will be staffed by a Department of Justice lawyer who is likely to take a very close look at your claim. While some ERC claims are obviously valid, others can present factual and legal questions that can lead to differences of opinion with government lawyers. In most cases you will be better off giving the IRS space to review your claim as you can always go to court later if the IRS disallows it, effectively giving you two bites at the apple. While some clear cases can be resolved in court for relatively little cost, taxpayers with more challenging cases can expect to pay more.
What to Do If the IRS Denies Your ERC Refund Claim
The IRS announced in August that it had denied 28,000 ERC claims. The agency used analytics to deny those claims, and many practitioners complained that the analytics were flawed. To his credit, the IRS Commissioner reported that the agency had taken that feedback into account in more recently deciding to grant a majority of the pending ERC refund claims. Although the IRS continues to deny ERC claims, that activity seems more sporadic. Regardless, if the IRS denies your ERC refund claim, I’ve written about what you should do here.
What to Do If the IRS Sends You an ERC Recapture Letter
In an August press release, the IRS announced that it was going to “mail up to 30,000 new letters to reverse or recapture” ERC refunds that had already been paid. The form of notice the agency uses is Letter 6577-C, Employee Retention Credit (ERC) Recapture. If you receive such a letter and do not respond to it, the IRS will treat the refund that it believes was paid in error as an underpayment of tax and will immediately assess and commence collection efforts. You might be able to resist these collection efforts in a collection due process proceeding, and the IRS should notify you about how that works in its collection correspondence.
The IRS’ authority to recapture ERC refunds is questionable and may be challenged in future litigation. This is an important consideration for taxpayers who are deciding whether to remit their refunds back to the IRS in response to a recapture letter. Kids in my neighborhood used to say, “Possession is nine tenths of the law.” This may be one situation where that is true. If the courts ultimately determine that the IRS does not have authority to issue recapture letters, you would be far better off with the money in hand than trying to get it back from the IRS, if the IRS’ lack of recapture authority is your only basis for recovery, due to an old Supreme Court case called Lewis v. Reynolds.
What to Do If you Have Not Filed your ERC Refund Claim
I suspect that the early IRS claims that the ERC program was rife with fraud may have dissuaded some eligible businesses from filing refund claims. Taxpayers who got cold feet because of all the noise may want to reconsider. Unfortunately, the time to file a refund claim for 2020 has now expired, and the time to file for 2021 will run out on April 15, 2025 (and may have already expired as legislation that would retroactively terminate the program as of January 31, 2024, has been introduced twice, although not enacted).
Keep in mind that eligibility for the credit is sometimes uncertain. As noted above, some cases may present factual or legal issues over which taxpayers and the IRS can disagree. Recognizing that there is often some uncertainty in tax positions, the tax law only requires taxpayers to have “substantial authority” for a tax position to avoid accuracy related penalties (and a lesser “reasonable basis” if they disclose the position to the IRS).
There is also a question whether the IRS has authority to assert penalties on refund claims of employment taxes as the statute that normally allows the IRS to assert penalties on erroneous claims for refund only applies to income taxes. I’m not suggesting that taxpayers should file baseless claims without fear of reprisal, but only that taxpayers who have had penalties asserted against them should consider whether the IRS exceeded its authority.
In conclusion, time is running out for taxpayers to file meritorious claims, which include more than claims where eligibility is absolutely certain. Taxpayers who want more protection against potential penalties can consider disclosing the issue to the IRS or getting tax advice from an independent tax professional (either of which will provide some level of penalty protection).
Tom Cullinan, a shareholder in Chamberlain Hrdlicka’s Atlanta office, served as counselor to the IRS Commissioner from 2018 to 2022 and acting IRS Chief of Staff for nine months in 2022.
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