Want to Sue the IRS for Unpaid ERC Claims? Consider These Factors

Is filing a lawsuit the best way to get the IRS to pay an unpaid employee retention credit claim? Some businesses think so, but before filing a suit, they should consider how they qualified for the ERC, the size of their claim, and their access to capital, among other things.

ERC fraud, in many cases orchestrated by tax credit promoters, led the IRS to issue refunds to businesses that didn’t qualify. Once the IRS discovered the extent of the fraud, it instituted a moratorium on processing ERC claims and developed processes to better screen claims for eligibility.

Although the IRS has lifted its moratorium on processing claims filed before Jan. 31, 2024, many businesses that legitimately claimed the ERC still haven’t received payment. It could take several more months before the IRS processes their claims.

Businesses that claimed the credit but didn’t receive a refund or notice of disallowance from the IRS within six months may sue the IRS for their refund. Such lawsuits can be filed either in the federal district court where the business is located or in the Court of Federal Claims in Washington, D.C. In either venue, the Justice Department attorneys would represent the IRS.

Before filing a lawsuit, businesses should consider several factors.

Most businesses have two ways to qualify for the ERC: experiencing a significant decline in gross receipts or being subject to a government order that fully or partially suspended their operations.

Businesses that satisfy the gross receipts test are better positioned for filing refund suits than those that qualify under the government orders test. The former is a straightforward calculation comparing a business’s gross receipts in a quarter during which the ERC was available to the gross receipts earned in the corresponding quarter of 2019.

By contrast, the government orders test has been the subject of much discussion and muddy IRS guidance. There is legitimate debate over what constitutes a government order, how much of an impact the government order had on a business, and whether certain impacts rise to the level of a full or partial suspension of business operations.

This uncertainty means the IRS is more likely to challenge ERC claims based on satisfying the government orders test. It’s easy to get bogged down in litigation fighting over government orders and their impact, which makes ERC claims based on government orders less ripe for refund suits than claims based on the gross receipts test.

Litigation is expensive, and it isn’t economical to sue for a small refund. Businesses with smaller claims are better served waiting for the IRS to process their claim (while earning refund interest during the delay).

Even if a business has a large ERC claim, it may be difficult to afford litigation expenses if its litigation attorneys charge hourly rates for their time and bill clients monthly. A business impacted by Covid-19 and seeking an ERC refund might not be able to afford litigation costs. To assist these types of businesses, attorneys may agree to handle ERC refund litigation on a contingent fee or alternative fee arrangement.

The benefit of a contingency fee is twofold. First, businesses may not have to pay any litigation fees until they recover their ERC refund. Second, attorney fees are ultimately paid from the ERC refund, so businesses don’t need access to other funds to sue the IRS.

Businesses with substantial unpaid ERC claims and those willing to share a percentage of their refund with their lawyers are good candidates for ERC refund litigation.

A business should consider how quickly it needs ERC funds and if it has access to capital through other avenues. Suing the IRS may lead to the business receiving ERC funds sooner, but it may make more sense to wait for the IRS to process the claims if the ERC funds aren’t critical to the business’s continuing operation.

It also may make sense to wait for the IRS to process the claim if the business has access to a line of credit. Waiting could save the business on legal fees.

If a business needs capital and can’t borrow through traditional lenders, suing the IRS for ERC refunds may be a better option—especially if the business qualified for the ERC based on the gross receipts test and has counsel willing to accept a contingent fee. Also, businesses that claimed the ERC for quarters in 2021 but filed returns after Jan. 31, 2024, should consider refund litigation, as the IRS hasn’t announced when it will process returns filed after that date.

Businesses that have experienced a significant decline in gross receipts and believe they are entitled to a large refund are best suited for refund litigation. They also need to ensure they can afford the upfront costs of the refund litigation or find legal representation willing to enter a contingency fee arrangement.

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

Matthew D. Lee is partner at Fox Rothschild, focused on white-collar criminal defense and investigations, federal tax controversies, financial institution regulatory compliance, and complex civil litigation.

Brian C. Bernhardt is partner at Fox Rothschild, focused on federal tax controversies and arguing precedent-setting appeals in the state courts of North Carolina.

Jonathan M. Wasser is an associate at Fox Rothschild, focused on federal and state tax controversies.

Matthew S. Adams contributed to this article.

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