The Employee Retention Credit—How to Litigate and Resolve Claims

The Employee Retention Credit (“ERC”), enacted in March 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, was designed to help employers keep their employees on payroll during the Covid-19 pandemic by offering a refundable tax credit against certain employment taxes. See Pub. L. No. 116-136, as amended. The IRS has issued more than $242 billion in ERC as of early 2025. Unfortunately, the processing and payment of ERC claims have faced considerable delay. The IRS initially imposed a moratorium on the processing of new claims in September 2023 to address the backlog of unprocessed ERC claims and to identify fraudulent claims. At least one plaintiff challenged the IRS moratorium, arguing that it violated the Administrative Procedure Act and that the agency cannot as a matter of law desist from processing claims. See Stenson Tamaddon LLC v. United States, No. 2:24-cv-01123 (D. Ariz.). Then, on August 8, 2024, the IRS announced that it was ending the moratorium and would begin processing the claims filed between September 14, 2023, and January 31, 2024. Despite the IRS resuming processing, millions of ERC claims remain in a state of flux. The uncertainty surrounding the ERC has not been abated under the new Trump administration, which is seeking to implement major personnel changes within the IRS. How exactly these changes will affect the processing of ERC claims remains to be seen.

As of today, ERC claims are generally found in one of four stages: (i) no IRS action has been taken on the claim; (ii) the IRS is examining the claim; (iii) the IRS has disallowed the claim; or (iv) the IRS paid the claim but is seeking recapture. Taxpayers with ERC claims in any of these stages can pursue payment of their ERC claims through litigation. This article summarizes each stage and outlines a taxpayer’s litigation path to pursue payment by stage.

Stage I—No IRS Action Taken on a Claim

As of October 26, 2024, more than 1.2 million ERC claims remained unprocessed, with many claims pending for more than a year as of that date. Some taxpayers seeking action on their ERC claim have sought assistance from the Taxpayer Advocate Service (“TAS”) by filing Form 911, Request for Taxpayer Advocate Service Assistance, or by contacting their Congressional representatives. However, even with TAS assistance, many taxpayers are still waiting for their claims to be processed. There is no statutorily required timeframe in which the IRS must process an ERC claim so it is unclear how long taxpayers with unprocessed claims will be waiting for their ERC payments.

Litigation Analysis—No IRS Action Taken on a Claim
Taxpayers should consider litigation to accelerate processing and payment of their ERC refund claims. As long as the claim has been pending with the IRS for six months without IRS action, the taxpayer has the right to sue for payment of the claim in their respective US district court or in the US Court of Federal Claims. The district court in which a taxpayer would file suit is based on the judicial district of the taxpayer’s principal place of business (or primary residence, if a sole proprietorship). The Court of Federal Claims is in Washington, DC. In both courts, the government will be represented by the Department of Justice.

The choice of whether to sue in district court or the Court of Federal Claims may depend on several factors, including different precedent each court may be subject to and the basis on which the claim has been made (e.g., the “suspension test” versus the “gross receipts” test). Taxpayers are strongly advised to seek competent litigation counsel in selecting their forum before litigating their ERC claim. For guidance on how to initiate an ERC refund claim suit, see “Stage III - Claim Formally Disallowed,” infra.

Stage II—IRS Examination of the Claim

The IRS is authorized to investigate the merits of a taxpayer’s ERC claim via examination (commonly referred to as an “IRS audit”). The IRS will initiate its examination by sending the taxpayer a Letter 6612 stating that the taxpayer’s claim is under examination and include a Form 4564, Information Document Request, seeking certain information pertinent to the ERC claim.

If the IRS exam team proposes that the claim should be disallowed in full or in part, the taxpayer will generally receive a Letter 5376, Full/Partial Claim Disallowance, which will give the taxpayer 30 days to either request a conference with an IRS exam supervisor or file a protest to appeal the disallowance before the IRS Independent Office of Appeals (“IRS Appeals”). The protest must contain certain elements, including the grounds for why the IRS should allow the claim with documentation attached to support the claim. The Appeals Officer assigned to the case will confer with the taxpayer regarding the merits of the claim and will then issue a determination that will either allow the claim to be paid or disallow all or a portion of the claim by issuing a Letter 105-C (full disallowance) or a Letter 106-C (partial disallowance). Unfortunately, IRS Appeals’ review may take several months and potentially even a year. Letters 105-C and 106-C considerations are addressed below under “Stage III - Claim Formally Disallowed,” infra.

Litigation Analysis—IRS Examination of the Claim
As stated above, a taxpayer has the right to file a lawsuit after six months from the filing of the ERC claim even if their claim remains under IRS examination. Although a taxpayer will typically wait until after IRS Appeals consideration to file a refund suit, a taxpayer should consider litigating if the IRS exam team is indicating that their claim will be disallowed and the taxpayer does not expect a successful resolution in IRS Appeals. For guidance on how to initiate an ERC refund claim suit, see “Stage III - Claim Formally Disallowed,” infra.

Stage III—Claim Formally Disallowed

As of August 8, 2024, the IRS has formally disallowed more than 28,000 ERC claims. The agency estimates that these ERC claims total $5 billion. The IRS called these 28,000 letters the “first significant wave” of disallowances, suggesting that additional waves are forthcoming.

Unlike the Letter 5376 informal proposed claim disallowance discussed above in the context of an IRS examination, the IRS formally disallows an ERC claim by issuing Letter 105-C (full disallowance) or a Letter 106-C (partial disallowance). Taxpayers who have received Letters 105-C and 106-C still have IRS Appeals rights to the extent a protest is filed within the required timeframe, but the issuance of the formal claim disallowances begins a two-year statute of limitations to file a refund suit from the date of the letter even if the taxpayer’s case is being heard by IRS Appeals. It is therefore critical that taxpayers monitor the deadline to file a refund suit during the pendency of the IRS Appeals process, as failure to timely file may result in a statutory bar from a court granting relief. See Estate of Orlando v. United States, 94 Fed. Cl. 286, 290 (2010). As opposed to Letters 105-C and 106-C, the Letter 5376 does not commence the running of the two-year clock on the statute of limitations to file a refund suit. Thus, the same statute of limitations concerns are not present.

In some instances the IRS has disallowed ERC claims because the taxpayer’s fact pattern did not satisfy the FAQ guidance that initially was published on the agency’s website and then republished as Notice 2021-20. Several taxpayers with disallowed claims have filed suit on the ground that this guidance failed to comply with notice-and-comment rulemaking as required by the Administrative Procedure Act. See e.g., Hammill Mfg. Co. v. United States, No. 3:25-cv-00462 (N.D. Ohio, Mar. 7, 2025); R.L. Morrissey & Assocs. Inc. v. United States, No. 1:25-cv-00460 (N.D. Ohio, Mar. 7, 2025). Through that pending litigation, the taxpayers are seeking to have the informal guidance set aside and their disallowances reversed.

Litigation Analysis—Claim Formally Disallowed
Taxpayers who received a Letter 105-C or 106-C but are currently before IRS Appeals should consider filing a lawsuit to toll the statute of limitations to protect against the possibility that IRS Appeals does not find in favor of the taxpayer or if successful, payment is not made within the two-year period. Alternatively, the taxpayer may seek to toll the two-year statutory period by requesting an agreement with IRS to extend the period for filing suit by executing Form 907, Agreement to Extend the Time to Bring Suit. In other words, if a refund suit is not filed within that two-year statute of limitations period or the period is not otherwise extended by agreement, the IRS is statutorily barred from issuing payment after two years, even if IRS Appeals later determines that the IRS should have allowed the credit in the first place. IRC §6532(a).

As alluded to above; to initiate a refund suit, a taxpayer must file a complaint in either their respective district court or the Court of Federal Claims. The taxpayer’s complaint must contain necessary factual allegations and the legal basis to support their ERC claim. An ERC complaint should include, for each quarterly period, statements such as:

The taxpayer qualified for ERC under one or more methods (e.g., decline in gross receipts);
The qualifying wages for ERC were not double-counted for PPP loan forgiveness purposes;
The ERC claim(s) was timely filed with the IRS on Form(s) 941/941-X;
The ERC amount(s) sought in the lawsuit was so claimed administratively; and
The two-year statutory limitations period for filing suit has not expired, or the period for filing suit was extended by mutual agreement.

The government will have 60 days to answer the complaint upon service by the taxpayer. Fed. R. Civ. P. 12(a)(2)). After the answer, the court will likely order the parties to confer and file a case management plan addressing discovery and schedules. This stage of the litigation will often present opportunities for settlement. If the parties do not agree to settle, the court or a jury will decide whether the refund is paid. A taxpayer prevailing on an ERC claim in court may be able to recoup attorneys’ fees from the government. See IRC §7430.

The procedure for litigating an ERC claim will often depend on the court and its local rules. Taxpayers are advised to seek counsel familiar with the rules of the forum in which their claim will be litigated.

Stage IV—IRS Recapture of ERC Payments

The IRS has the authority to “claw back” or recapture ERC if it determines that the credit was erroneously allowed. Normally, if the IRS issues a tax refund, credit, or other benefit in error, the government must bring a civil lawsuit against the taxpayer to recapture the amounts if the recipient does not return them voluntarily. See IRC §6532(b). But the Department of Treasury has adopted the view that recovery of an ERC is different: According to Treasury regulations finalized in July 2023, an erroneously allowed ERC is treated as an underpayment of employment taxes, and the IRS is authorized to recoup these amounts through administrative assessment and collection procedures. See 88 Fed. Reg. 48188. Under proposed regulations issued in July 2024, the IRS is authorized to assess and collect interest on erroneous ERCs. See 89 Fed. Reg. 54742. Treasury’s authority to promulgate regulations in this space is likely susceptible to challenge, particularly in the face of the prescribed statutory procedures on bringing erroneous refund suits. Taxpayers that are the target of ERC recapture efforts are thus advised to consider making a regulation validity challenge in court. For more information, see the final paragraph of this Part IV.

The ERC recapture process typically begins with the issuance of a Letter 6577-C, notifying the taxpayer that the ERC claim was (allegedly) improper. A taxpayer can challenge the proposed recapture by replying to the Letter 6577-C with a statement explaining the reason for the disagreement and including relevant facts to support the claim. Letter 6577-C will typically give the taxpayer 30 days or less to respond. On August 15, 2023, the IRS announced that it would be issuing up to 30,000 such letters, mostly relating to claims paid for periods in 2021. The IRS had previously sent more than 12,000 letters relating to claims made for periods in 2020.

Consistent with the general statute of limitations on assessment, the IRS has three years in which to recapture by assessment ERC attributable to 2020 and to Q1 and Q2 of 2021. See IRC §6501(a). This three-year period runs from the later of (1) the date on which the return claiming the ERC was filed or (2) April 15 of the calendar year following the taxable quarter. Thus, the IRS had until April 15, 2024, in which to recapture by assessment ERC that was timely claimed on original Forms 941 for 2020. This means that most claims paid before the September 2023 moratorium will be insulated from recapture. The IRS has until April 15, 2025, in which to recapture by assessment ERC that was timely claimed on original Forms 941 for Q1 and Q2 of 2021. It is important to note however that the government retains the ability to recover ERC through civil litigation. The government may be able to recover ERC in this manner if it files suit against the taxpayer within two years of when the ERC was paid. See IRC §6532(b).

There is a different rule for ERC claims attributable to Q3 and Q4 of 2021. See IRC §3134(l). For those periods, Congress gave the IRS a five-year statute of limitations. Thus, the IRS will have until April 15, 2027, in which to recapture ERC that was timely claimed on original Forms 941 for Q3 and Q4 of 2021. Neither the three-year nor the five-year statutes of limitations apply in the case of ERC claims that are attributable to fraud—for fraudulent claims, the statute of limitations on assessment is unlimited. IRC §6501(c)(1).

Litigation Analysis—IRS Recapture of ERC Payments
Taxpayers who have been targeted for ERC recapture and have not been successful in convincing the IRS otherwise should expect the IRS to attempt to collect payment through lien and/or levy under the finalized regulations. The IRS must notify the taxpayer of collection by issuing a Letter 3172, Notice of Federal Tax Lien Filing, and/or Letter 1058, Final Notice of Intent to Levy. These notices include a Form 12153, Request for a Collection Due Process (“CDP”) or Equivalent Hearing, which allows the taxpayer to request a hearing before IRS Appeals.

Taxpayers wishing to avoid IRS collections and liens have 30 days to file a Form 12153 for a CDP hearing before IRS Appeals with US Tax Court review or if filed after 30 days but within one year, a taxpayer can still receive an equivalent hearing before IRS Appeals without US Tax Court review. In both the CDP and equivalent hearings, the taxpayer will have the opportunity to establish eligibility for the ERC. IRS Appeals will issue a Notice of Determination after the CDP hearing or a decision letter after the equivalent hearing.

A taxpayer receiving an adverse determination after a CDP hearing can litigate its claim in the US Tax Court. There the taxpayer will have the opportunity to prove its entitlement to the ERC. Tax Court review is not available, however, if the taxpayer had “an opportunity to dispute [the] tax liability” previously. IRC §6330(c)(2)(B). Thus, a taxpayer that receives Letter 6577-C may not have the option of Tax Court review if it already appealed the proposed or formal disallowance of its ERC claim at IRS Appeals. Lewis v. Comm’r, 128 T.C. 48, 61 (2007).

A Tax Court petition is required to be filed within 30 days of the date shown on the Notice of Determination. An adverse decision in the Tax Court may be appealed to the US Circuit Court in which the taxpayer has its principal place of business (or primary residence if a sole proprietorship). As an alternative to CDP or Tax Court, a taxpayer can pay the amounts targeted for recapture, file an administrative claim for refund, and sue for the amounts in a district court or the Court of Federal Claims.

Taxpayers who do find themselves before the US Tax Court should consider challenging Treasury’s authority to promulgate regulations that provide that an erroneously allowed ERC is treated as an underpayment of employment taxes. Some practitioners have suggested that the governing statutes do not permit the IRS to directly assess erroneous ERC. If these regulations are successfully challenged on either procedural or substantive grounds, the IRS may not be authorized to recapture ERC through administrative assessment and collection procedures outlined above and may result in the taxpayer being able to retain their ERC payment.

Conclusion

The ERC is a crucial tax benefit available to employers harmed by the Covid-19 pandemic. Unfortunately, enhanced IRS scrutiny has caused many meritorious claims to be delayed, disallowed, or targeted for recapture. This article provides a broad overview of the stages of ERC claims and potential ways in which taxpayers can resolve their ERC claims. However, this article merely serves as an introduction on the subject and taxpayers are advised to consult with counsel who can assist them by developing and implementing strategies to expedite and maximize the payment of ERC under their particular circumstances.

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

Shawn O’Brien is a partner who focuses his practice on tax litigation and controversies involving state, federal, and international tax authorities. He represents clients in tax examinations and administrative appeals and, when necessary, serves as a forceful advocate in litigation before the US Tax Court, US district courts, the US Court of Federal Claims, state courts, and federal appellate courts.

Michael J. Scarduzio is an associate who focuses his practice on US and international tax matters, particularly civil and criminal tax litigation. From audit to litigation, he represents taxpayers in all phases of tax controversy.

Samuel F. Hamer is an associate who focuses his practice on US and international tax matters. Prior to joining McDermott, he served as a judicial law clerk to the Honorable Albert G. Lauber of the US Tax Court.