by Natalie Graumhaus
ERC Today v. McInelly Challenges IRS Method of Processing ERC Claims
Since the IRS has started processing the backlogged ERC claims after the end of the moratorium this year, they have been sending out a significant number of automatic denials and partial disallowances before asking for additional clarification from taxpayers. Those notices have come primarily in the form of 105-C letters entirely disallowing the claim due to employer ineligibility, or 6577-C letters partially disallowing the claim due to an alleged overclaim of employees. This has led to growing frustration, with tax preparers who have made proper claims being rejected unjustly. A new federal lawsuit brought by two such preparers may draw more details from the IRS on their process and potentially offer some relief from the automatic disallowances.
Legal Action Against the IRS
Two tax preparation firms, ERC Today LLC and Stenson Tamaddon LLC, filed suit against the IRS on November 13, 2024 in the Federal District Court for the District of Arizona asking the federal district court to stop the IRS from issuing automatic disallowances. This week, on January 7, 2025, the plaintiffs filed a motion for a preliminary injunction against the IRS and the IRS Commissioner to prevent any additional automatic disallowances from being sent out. The plaintiffs claim that these notices are based on “arbitrary and capricious” processing methods and constitute a violation of taxpayers’ due process rights, as no specific or factual reasons are provided in the boilerplate of the notices and create limitations on the normal administrative review rights available to taxpayers who receive such notices. The most concerning of these limitations is that these denials eat into taxpayers’ two-year window for appeals leaving them with significantly less time for a true appeal, since the automatic denials realistically function as audits – per the notices, any protest in response is considered by the Examinations department before being sent on to Appeals.
Despite the IRS alleging that the reason for the ERC moratorium and the continued delays in processing claims and audits was to allow them to “[take] a closer look at every single claim”, the boilerplate notices, many directed at proper claims, suggest otherwise. Additionally, as the plaintiffs’ motion points out, the IRS “claims that its filters are ‘privileged’ and therefore non-public, including all ‘criteria indicating improper ERC claims, the method of assigning risk levels to ERC claims, the method of processing ERC claims based on various risk levels, and the refinement of risking treatment as data on ERC claims have been collected.’” This makes it difficult for taxpayers to ascertain whether they may be at risk of audit and/or denial, even if they properly filed claims.
The motion also underscores the IRS’s inability to factually determine eligibility under either the gross receipts test or the government orders test. The Form 941-X submitted to claim the ERC credit by employers lacks the detailed information on 2019 quarterly returns necessary to pass the gross receipts test, while the highly individualized nature of the government orders test—requiring analysis of city, county, and state orders along with industry-specific impacts—renders automated determinations ineffective.
Broader Concerns Raised by the National Taxpayer Advocate
The National Taxpayer Advocate also highlighted many of these same issues with the delays in processing and the lack of transparency and standard audit protections in the disallowances in its annual report. The Advocate noted that there was still a backlog of 1.2 million claims in October 2024. After this report was submitted, the Commissioner announced that the IRS plans to process 500,000 in 2025.
Looking Ahead
If the court grants the injunction, it could mark a significant shift in how ERC claims are processed. However, federal courts have their own delays and backlogs, and it may take up to 1-2 months for this motion to be heard and ordered if it is granted by the judge, and many more disallowances may be sent out in the meantime.
If you are a Tri-Merit ERC client who has received one of these notices, let our audit team know immediately. We will respond on your behalf and get the appeal rolling. In the plaintiffs’ words in this suit, “Administrative convenience will not excuse policies that contravene taxpayer rights.” We are proud to offer effective and excellent audit representation to our clients at no additional cost – that’s how confident we are in the claims we prepare.