For those of us justifiably dissatisfied with this season of House of the Dragon, recent ERC action may lend some much-needed excitement—some might say gore? Last month, the IRS issued nearly 30,000 denial letters to taxpayers for ERC claims it deemed are of the highest risk of being fraudulent. This comes just as a U.S. District Court for Arizona denied a consulting firm’s Motion for Preliminary Injunction seeking to lift the government’s moratorium on processing new ERC claims. To boot, the IRS continues to issue new “warning signs” of potentially erroneous claims even as serious concerns have mounted about the reliability of its digital processing systems.

            All this seems rather bleak for taxpayers, but there may be a flicker on the horizon. What then should a taxpayer do if they received a denial letter or are waiting to hear back about a filed claim? After a denial letter, a taxpayer’s two main avenues of relief are: (1) filing a protest with the Independent Office of Appeals and (2) filing a refund suit (or both). While litigation is often the choice of last resort, taxpayers should take note that once they receive a notice disallowing their claim, they only have two years to file a refund suit in District Court. Here are some other things consider for taxpayers who received a denial letter and continue to believe in the validity of their claims.   

            First, taxpayers should not waste time in preparing a protest letter to the Independent Office of Appeals. A taxpayer has 30 days from the date of their denial letter to file a protest with Appeals, and those who received July letters are cutting it very close if they have not begun this process. Although anyone can file a protest, it may be in a taxpayer’s best interest to seek professional help. Failing to file a protest, even if the case is destined for litigation, is an unnecessary waste of a potentially cost-effective claim resolution.

            Next, take stock of the claim and determine where it likely stands on the government’s risk meter.  If the SBA forgave a PPP Loan based on wages paid during the periods for which a claim was filed, it would be worthwhile to triple check that the wages claimed for PPP loans are distinct from those on which the ERC claims are based. Other wage-based issues the government seems keen on targeting are family or related-individual wages and wages paid by certain employers (greater than 500 employees for the first and second quarters of 2021) to employees who performed services. Proper record-keeping of wage information is an effective way of justifying the claim to an appeals officer. Less-substantiated claims may be best left to a refund suit.

            Another consideration is whether the claim is based on a gross receipts test or a government order test. Clear substantiation that gross receipts meet the applicable standards for the quarters at issue is a great issue for the Independent Office of Appeals. The government seems to have dropped the ball on this analysis in its new processing system. This may be due to the inadequacy of Form 941 for the purpose of processing ERC claims. A more subjective government order analysis may be better pleaded by counsel in litigation.

            Finally, and perhaps the most significant consideration, is the size of the claim. A refund suit in District Court or the Court of Federal Claims is costly but lends some finality to a landscape that has so far been riddled with delays. Even with Inflation Reduction Act funding, the IRS is flooded with claims and litigation may be an appropriate way to compel agency attention to a well-substantiated claim. The government may be willing to settle these claims, especially now that the Relief Act has failed in the Senate. Taxpayers who have not received a decision on their claims may also consider litigation if six months have elapsed since their filing date. Of course, this would apply to just about everyone given the moratorium last fall.  

Taxpayers receiving denial letters should move quickly to weigh the risks and evaluate all of their options, including potential costs. Without additional action by Congress or the IRS changing course, we should expect a significant uptick in taxpayers fighting for valid claims in District Court.