IRS Policy, Chevron Ruling May Prove ERC Claims Unsustainable

The US Supreme Court’s ruling overturning Chevron deference, as well as the IRS’s own policies, suggest the IRS may be employing a harsh and legally unsustainable standard in assessing the merits of employee retention credit claims.

If true, the IRS may need to pay out many more ERC claims—and the agency may face additional challenges in making good on its pledge to hold promoters accountable for what it maintains were dubious marketing practices leading to the current surge of claims.

The controversy lies in that most of the IRS concerning eligibility for the ERC are found in sub-regulatory guidance, predominantly in the form of a 104-page IRS notice called Notice 2021-20, as opposed to the ERC statute itself.

With the IRS announcing June 20 that it will resume proceessing some ERC claims, it is important to know what rules the IRS is using to address the eligibility of the ERC.

The ERC statute, codified in Section 3134 of the tax code, creates two paths to eligibility. One is an objective test that compares the company’s gross receipts to pre-pandemic revenue. The other (where most of the controversy lies) is a subjective test that asks if the business’s operations were “fully or partially suspended” during the relevant period “due to” a government order.

The statute leaves much to interpretation regarding the subjective test for eligibility, which is the test most ERC claims rely on. For instance, it doesn’t define what constitutes a full or partial suspension of business operations, nor what constitutes a government order for purposes of the statute.

The IRS tried filling some of the gaps in the statute by issuing Notice 2021-20, which placed limits on eligibility and imposed obligations on ERC claimants that weren’t contained in the ERC statute.

For instance, the notice said businesses would have to demonstrate that a “partial suspension of operations” had more than a “nominal impact” on their business—essentially showing that the suspended area represented more than 10% of the business’s total revenue or labor force. Such a test doesn’t appear in the ERC statute, and neither does the record-keeping requirements that were imposed by Notice 2021-20.

Actions and positions that the IRS has taken suggest that it views Notice 2021-20 as the definitive word on interpretating the ERC statute. In conducting audits, IRS examiners measure a claimant’s eligibility by their complaince with Notice 2021-20, , frequently citing the notice in examination reports rejecting claims.

IRS counsel also has referred to Notice 2021-20 as operative law in legal advice memoranda. Perhaps more significantly, the IRS repeatedly has called out ERC promoters for allegedly processing claims that don’t comply with the notice.

Notice 2021-20’s status as binding authority has come into question. An ERC claimant and a promoter have filed lawsuits in the past few months seeking to vacate Notice 2021-20 on the grounds that the IRS violated the Administrative Procedure Act by issuing it.

The plaintiffs argue that the IRS issued what it treats as a substantive (as opposed to interpretive) rule without complying with the APA’s notice and comment procedures for such rules.

The Treasury Department in 2019 said that sub-regulatory guidance, which includes IRS notices, “is not intended to affect taxpayer rights or obligations independent from underlying statutes or regulations” and that the IRS wouldn’t argue that such guidance was entitled to deference by courts.

But the Supreme Court’s June decision in Loper Bright Enterprises v. Raimondo signals that sub-regulatory guidance such as Notice 2021-20 may have even less significance. Reversing 40 years of Supreme Court precedent, Loper Bright held that agency gap-filling regulations aren’t entitled to deference.

After Loper Bright, it is doubtful that an agency will be able to rely on subregulatory guidance. The ruling is likely to provide additional ammunition to the plaintiffs in the lawsuits challenging Notice 2021-20 as they play out of the coming months. If the notice is vacated or its significance is diminished by courts, more ERC claimants may be entitled to relief.

Additionally, the attacks themselves on Notice 2021-20 present significant challenges to the IRS’s enforcement efforts against ERC promoters. They provide a basis to argue that a promoter’s advice was either consistent with the ERC statute or based on a good faith belief that Notice 2021-20 was unenforceable.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Christopher Ferguson is partner at Kostelanetz focusing on white-collar criminal defense, civil and criminal tax controversies, and other regulatory enforcement matters.

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