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Recent IRS ERC Update May Increase Necessity of Refund Lawsuits

By Jeffrey M. Glassman on June 21, 2024
Employers are facing a pivotal moment with the Internal Revenue Service’s (IRS) latest announcement regarding the Employee Retention Credit (ERC). In a news release dated June 20, 2024 (link) the IRS acknowledged that it is about to deny a material amount (“tens of thousands”) of ERC claims based on the IRS’s identification of “risky… and improper claims.” It is entirely plausible that under this risk-based approach—which the IRS now states will result in billions of dollars of denied claims—valid ERC claims may face denial, necessitating potential litigation to challenge such decisions. Indeed, in a recent court filing, the government argued that taxpayers had not suffered sufficient harm by the moratorium, because they are free to file refund lawsuits. See Stenson Tamaddon, LLC v. IRS, No. 2:24-cv-01123 (D. Ariz.) (June 14, 2024).

The IRS’s news release, IR-2024-169, states: “The completion of this review provided the IRS with new insight into risky Employee Retention Credit activity and confirmed widespread concerns about a large number of improper claims.” This statement underscores the heightened scrutiny that ERC claims will now undergo. The IRS Commissioner, Danny Werfel, emphasized, “We will now use this information to deny billions of dollars in clearly improper claims and begin additional work to issue payments to help taxpayers without any red flags on their claims.”

The IRS categorized the claims into three risk levels: high, medium, and low. The IRS’s high-risk category, comprising 10% to 20% of ERC claims, shows what the IRS believes to be clear signs of being erroneous and will be denied in the forthcoming weeks. According to the IRS, these claims fall outside the guidelines established by Congress and include filings with warning signals that are clearly improper.

For the IRS’s medium-risk category, which accounts for 60% to 70% of ERC claims, the IRS will conduct further analysis to gather more information. The IRS stated that this step aims to improve the agency’s compliance review and expedite the resolution of valid claims while safeguarding against improper payments. It remains unclear how long these claims will take to resolve.

The IRS’s low-risk category, representing 10% to 20% of ERC claims, will see judicious processing of claims with no eligibility warning signs. The IRS anticipates issuing the first payments from this category later in the summer, albeit at a slower pace than during the pandemic, due to the need for increased scrutiny.

The IRS cautioned taxpayers and practitioners alike that the processing of ERC claims will be a protracted process, and they should not expect the same speed as last summer. The IRS further advised taxpayers to await further notification from the IRS and refrain from calling the toll-free lines, as additional information on these claims is not readily available.

Werfel also advised, “Anyone applying for this credit needs to talk to a trusted tax professional and closely review the eligibility requirements, not someone playing fast and loose and trying to make a fast buck off well-meaning taxpayers.”

The possibility that valid ERC claims could be denied is a stark reminder of the need for potentially challenging such decisions through litigation. The likelihood that the IRS will deny valid claims cannot be eliminated.

If you have any questions about this article, the employee retention credit, or any other civil or criminal tax matter, please contact me at 214-749-2417 or jglassman@meadowscollier.com.