The Internal Revenue Service is continuing to challenge and audit claims for the Employee Retention Credit, extending the yearslong backlogs on processing the often dubious claims.
Tom Cullinan, a former IRS chief of staff and counselor to the IRS commissioner who is currently a shareholder with the law firm Chamberlain Hrdlicka, is seeing the IRS paying few of the remaining refund claims. The agency instead appears to have decided to audit most of the remaining claims.
"Most IRS audits seem to result in denials, often using 'pattern' Letters 105C that misdescribe the underlying claim," he said. "While the IRS is still allowing some claims, those seem limited to gross receipts or very clear-cut claims for partial suspension. Claims for the 3Q21 are especially unlikely to be granted."
The IRS denied approximately 28,000 claims in the summer of 2024, he noted. "Many (perhaps most) taxpayers who decided to protest those denials are still waiting for their appeals conferences," he said.
The IRS recently instituted an important change that should allow taxpayers to work with the IRS to extend the time that they have to file suit, he noted, but few taxpayers are having much success at meeting with IRS Appeals.
"At the same time, the IRS continues to seek the recovery of some claims previously paid," he added. "Although the IRS has run out of time to open new audits on most claims that it paid, the audits that it did timely open continue to progress through audit and then to IRS Appeals. All this means that a lot more (perhaps hundreds or thousands) of ERC cases are going to end up in court."
The IRS has been cracking down on ERC claims after seeing a
In April, the IRS announced it was
"The ERC inventory has shrunk dramatically, but the cases that remain are the hard ones," said Mark Friedlich of Friedlich Law Group and Hall Lundstedt in a recent
Despite the limits on new claims for the ERC, Cullinan is seeing a great deal of activity. "I was at IRS when the program was first instituted, and I felt pretty proud of the work that we did while we were there on all those fronts," he said. "But now there's still a lot of unresolved claims, unresolved issues that relate to claims that were already filed. You can put those into a couple of different buckets. The IRS, in some cases, is trying to recover funds that it believes that it had paid an error, so it granted refunds, and then after the fact has decided that it has some doubts about whether those refunds were proper. We've seen a bunch of audits opened up where the IRS is questioning whether refunds that have already been paid should have been paid."
It's doing that in a different way than usual. "There are some interesting procedural questions surrounding all that, because historically, the way the IRS would go after refunds of employment taxes that it thought had been paid in error was to bring litigation through the DOJ," Cullinan added. "That's not realistic from a resource perspective. If the IRS thinks thousands or even just hundreds of claims have been brought in error, it's unlikely that it's bringing litigation and district courts to chase after that. But what the IRS did is it promulgated a regulation that the IRS believes is grounded in the CARES Act legislation that purports to give the IRS unilateral authority to treat amounts that it believes have been paid an error as an underpayment that it can immediately assess. It's very different than your normal tax controversy procedural dynamic in that the taxpayer is not going to get a notice of deficiency. It's just going to be an assessment like 'here, give us the money back.' It's a pretty different environment than what tax controversy people are used to, and there's a real doubt about whether the regulation that the IRS promulgated to give itself that authority is even valid. We're going to see all sorts of interesting questions pop up as a result of that."
Court rulings
In recent days, there were at least two court rulings in such cases. Last Thursday, the law firm Susman Godfrey announced that it had secured a favorable ruling in an ERC on behalf of Tri-State Memorial Hospital. In its decision, the U.S. District Court for the Eastern District of Washington
In a 21-page opinion, the court rejected the government's argument that Tri-State does not qualify for tax refunds under the "Suspension Test" of the CARES Act, holding that the test requires taxpayers to show "a temporary delay, interruption, or termination of a more than nominal portion of an employer's business." In its motion to dismiss, the federal government had argued that the Suspension Test requires taxpayers to "allege cessation of a significant portion of its operations" from a governmental order that "was the proximate, independent and sufficient cause of the suspension of its operations."
"We are pleased with the court's careful interpretation of the CARES Act," said Weston O'Black, a partner at Susman Godfrey representing the hospital, in a statement. "The government argued for a strict and narrow application of the Suspension Test that we believed was inconsistent with the statute's plain language. Now that we've moved past the government's threshold arguments about how to interpret the Suspension Test, we look forward to preparing the case for trial to help Tri-State receive the relief Congress intended."
However, in another ruling last Thursday in a different case involving a health provider, Northeast Health Services, the Court of Federal Claims adopted a
"Because the government orders exempted NEHS, and because the operational disruptions NEHS experienced were either voluntary, too attenuated, or proximately caused by general pandemic conditions rather than specific government mandates, NEHS failed to meet the statutory definition of an eligible employer under the suspension-of-business prong," wrote Ed Zollars of Thomas, Zollars & Lynch in his
Another case that's been stirring up action in the courts is the
"Taxpayers should proceed cautiously as the court in Kwong did not directly address eligibility requirements for specific credits or deductions, and these are possible implications of the court's reasoning rather than settled law," Collins cautioned in a
That case doesn't directly involve the ERC, though it's related to COVID-era tax refunds, penalties and interest. "It could relate to really anything else," said Cullinan. "It can relate to any underpayment or overpayment, because both have interest components to them rising out of those years regarding, so that type of argument could apply to an ERC claim, just as it could to anything else."
Outstanding claims
In February, the Government Accountability Office released a
"A PEO can file a claim on behalf of one business, 1,000 businesses, 10,000 businesses," said Cullinan. "They file one refund claim, and then there's a schedule in the back called Schedule R that aggregates all the claims."
During a meeting in March with the National Association of Professional Employer Organizations, the IRS clarified that approximately 185 PEOs' claims have not yet been processed, according to an
"It's really hard to know from the numbers that you see from the IRS how many claims are really still sitting at the IRS, but we have definitely seen a slowdown in refund activity," said Cullinan. "For a while there, the IRS was paying a lot of refunds, but that seems to have slowed down quite a bit, and we're seeing more audits claims that still are up there."
In many cases, the IRS has denied the refund, but taxpayers are appealing. "There was a big chunk of claims in July of 2024 where the IRS publicly announced that it had denied 28,000 claims," said Cullinan. "You've got two years to file a suit from the time that the IRS denies a claim. Those claims are starting to come up against a two-year statute."
He urged tax professionals and taxpayers to pay attention to that deadline. "If you're coming up on that two-year statute, you need to get it extended with the IRS," said Cullinan. "Otherwise, you're going to lose your claim, no matter how valid it is. Some of those claims are now at Appeals, or they already had their Appeals conferences, and some of them are getting some settlements. Many are not receiving offers, at least in my experience, that they see as being particularly enticing. Those taxpayers are beginning to move into court."
He advises accountants to manage their clients' expectations as best they can. "The IRS lost quite a few personnel, and the people that got left behind have all that much more responsibility, so we are unfortunately seeing the process take much longer to play out," said Cullinan. "That's true really, across the board, not just ERC. Things are just taking longer."
Accountants can still provide much-needed help to clients dealing with inflation and other headwinds. "It should be really satisfying for the accountants that are doing this type of work," said Cullinan. "It's not always the case that you can help a client get money that they're entitled to. Tax law is not always black and white, and the ERC, like so many areas of tax law, can be gray. The key is to resolve these cases in a way that takes that uncertainty into account in a way that's fair to the taxpayer and fair to the government. Some taxpayers just like to roll the dice and go to court and it's winner take all. There are at least two different paths you can take, but it's not always 100% clearcut as it is with a lot of things in tax law."
