The Employee Retention Credit (ERC) was designed to provide financial relief to businesses impacted by the COVID-19 pandemic, but many companies are still waiting for their refunds due to IRS processing delays. With no legal deadlines forcing the IRS to act, businesses are left in limbo, facing financial strain and uncertainty. As a result, many have turned to litigation to force the IRS to pay out the refunds they are owed. This guide explores why businesses are suing the IRS, who is eligible to file a lawsuit, the legal process involved, and what companies can expect when taking legal action to recover their ERC refunds.
Why Businesses Are Suing the IRS for ERC Refunds
The Lack of Legal Deadlines for IRS Processing
Unlike personal tax refunds, the IRS has no set deadline for processing ERC refunds. This lack of accountability has led to significant delays, leaving businesses without critical financial relief and no clear timeframe for when to expect their refunds.
Unjustified Denials
The IRS has already processed the smaller, lower-risk claims—about 10% of total filings. What’s left are the larger claims, like yours, which are either being delayed or outright denied. At our firm, we’ve received over 60 denial letters for claims that, based on our objective standards, should qualify for the ERC. The IRS has provided no clear rationale or explanation for why these claims are being denied.
Essentially, what the IRS is doing is delaying and denying claims without any real justification, much like an insurance company that drags its feet before denying a claim.
Backlogs and Processing Delays
The IRS has been overwhelmed by the volume of ERC claims, leading to long wait times—sometimes exceeding a year. This backlog has placed businesses in financial strain, unable to make key decisions or invest in recovery while waiting for their refunds.
Who Can File an ERC Lawsuit?
To file an ERC lawsuit, a business must have:
- Properly filed an ERC claim via Form 941-X (Adjusted Employer’s Quarterly Federal Tax Return).
- Waited at least six months without receiving a refund or formal denial.
When a Business Should Consider Litigation
At Brotman Law, we also recommend companies that fit the following criteria, file a lawsuit:
- Your Employee Retention Tax Credit claim is $250,000 or more, ideally $500,000 or more. Your claim has to be large enough for the government to fear that you will go the distance with litigation.
- Your business is dependent on a physical location and/or is human capital dependent for the production of goods or services.
- Your business was impacted by government orders related to COVID-19. Although the IRS safe harbor is not an absolute, businesses with more than a 10% drop in revenue or their ability to produce goods or services was hindered are better candidates.
- You would be able to document this impact through emails, financial and/or operational information showing an adverse impact on revenue or a reduction in capacity, or through us documenting this impact through employee witness statements. The more concretely you can show impact, the better (although we can help with this).
The Legal Process of Suing the IRS
What Judicial Action Involves:
- File a Timely Refund Claim: Ensure that your Forms 941-X were filed within the applicable statute of limitations. This is typically three years from the date the original Form 941 was filed or two years from the date the tax was paid, whichever is later (26 U.S.C. § 6511) [1].
- Wait for IRS Response: The IRS has no statutory obligation to process your refund claim within a specific timeframe. If the IRS fails to respond to your claim within six months, you can proceed to the next step (26 U.S.C. § 6532(a)(1)) [2].
- Initiate a Lawsuit: If the IRS denies your claim or fails to respond within six months, you can file a lawsuit in the relevant federal district court or the Court of Federal Claims (28 U.S.C. § 1346(a)(1); 26 U.S.C. § 7422) [3].
- Discovery/Exchange Documentation: Once the lawsuit is filed, attorneys for both the business and the government will exchange documentation and discuss the merits of the claim. This process can lead to a full allowance of the claim or a compromise (26 U.S.C. § 7422(a)) [3].
- Negotiate Settlement/Alternative Dispute Resolution: Because of the high volume of cases in federal court, judges will often encourage or strongly encourage the parties to reach a resolution prior to going far in the federal court process. Recently, the government has adopted a willingness to engage in settlement discussions or to pursue mediation or arbitration vs. taking the case to trial, which consumes a lot of time and energy on both sides.
- Motion for Summary Judgement: If dispute resolution does not work, usually one of the parties will file a motion for summary judgment, which is a motion for the court to decide the case based on the parties’ written submissions.
- Trial: If all else fails, the case will be set for trial and the Plaintiff will have their day in court.
- Decision: The judge in the case, or jury if the plaintiff opts for a jury trial, will ultimately decide the case.
Potential Outcomes of ERC Lawsuits
Early results in federal court have shown a clear trend: the IRS is increasingly willing to settle Employee Retention Credit (ERC) cases rather than litigate them. This is primarily because the IRS recognizes that a negative decision in federal court could set a damaging precedent for all ERC claims nationwide. Such a ruling would likely lead to a flood of litigation against the IRS for its failure to process these claims in a timely manner. The IRS is far more concerned about the overall ramifications of mass litigation than the individual results of each case.
We believe that many businesses were significantly impacted by government orders during the COVID-19 pandemic—more so than just nominally. If COVID restrictions had an effect on your business, it’s highly likely that you qualify for some level of relief. Federal judges, who are impartial in these matters, may likely side with businesses, as the evidence of impact is clear and the legal framework for relief is well-established.
Another important aspect is that businesses have the option to have their case decided by a jury in federal district court. This could allow for a broader perspective on the case and offer a greater opportunity to explain the specific hardships faced due to COVID-related restrictions.
Given these factors, we believe the Department of Justice (DOJ) Tax Division will be pressured to settle these cases more quickly than they typically would. With mounting cases and the potential for widespread legal repercussions, the IRS may choose to settle rather than risk a large-scale legal loss. In the right circumstances, businesses can be on the offensive, pushing their claims forward with confidence, knowing the momentum is in their favor.
Myths and Misconceptions About Suing the IRS
Addressing Fears of Retaliation
One of the most common misconceptions about suing the IRS is the fear that it will lead to increased scrutiny or retaliation, such as being added to a federal watchlist. However, this is simply not true. Suing the IRS, whether in your local district court or in the Federal Court of Claims, is not a threat to your business’s future. In fact, initiating a lawsuit against the IRS takes the decision out of the hands of the agency and places it in the hands of a neutral federal judge, ensuring that your case is evaluated fairly and objectively.
It’s important to understand that the IRS itself is not even present in court during these proceedings. When you file a claim against the IRS, it is handled by the Department of Justice – Civil Tax Division, which is also a disinterested party. The DOJ’s role is to defend the IRS, but their involvement does not imply any personal or punitive action against you as a taxpayer.
Why Suing the IRS Isn’t as Risky as It Sounds
Suing the IRS may seem intimidating, but it’s a standard legal process. Think of it like any other lawsuit—taking the matter to court means you’re removing it from the administrative process of the IRS and moving it into the hands of a judge who is neutral to both sides. This ensures that there will be a fair resolution and a definite end date to your case, unlike the indefinite waiting periods or uncertainty that can come from dealing directly with the IRS.
In fact, litigation is often the most direct and efficient path to resolving your case. By pursuing legal action, you’re not only ensuring your right to a fair hearing, but also gaining the certainty of having your case settled by a court. This judicial approach guarantees a resolution, allowing you to move forward with clarity and confidence, without fear of retribution.
Why Litigation Might Be Your Best Option
While we generally steer our clients away from federal litigation due to the cost and long timeline, the current situation with the Employee Retention Tax Credit (ERC) presents an unusual opportunity for certain businesses. Here’s why litigation may be the best course of action in your case:
Unprecedented Situation with the IRS and DOJ
The Department of Justice – Civil Tax Division is currently facing significant workforce reductions, meaning they no longer have the same capacity to handle the volume of cases they’ve dealt with in the past. With fewer resources available, the government is being forced to prioritize which cases it defends. This creates a unique opportunity for businesses to challenge delays or denials head-on, as the government may not be able to fully devote the time and attention required to litigate each case. As a result, taking action now may increase your chances of success.
Broad Relief Program vs. IRS’s Narrow Interpretation
The ERC was designed as a broad relief program to support businesses impacted by the COVID-19 pandemic. The statute itself was intentionally inclusive, aiming to help as many businesses as possible. However, the IRS has adopted an overly conservative interpretation of the credit, limiting eligibility unnecessarily. In fact, the IRS has already lost significant ground in ongoing court cases, such as Stemson v. IRS, where litigants have successfully challenged the IRS’s restrictive stance. These cases have questioned whether the IRS’s position is even valid, particularly under the Administrative Procedures Act, which requires agencies to follow proper procedures when implementing new policies.
Increased Likelihood of Settlements
Recent results in federal court suggest the government is more inclined to settle ERC-related cases rather than risk a court ruling against them. The IRS knows that a negative decision in court would not only affect the individual case but could set a precedent for all ERC claims nationwide. This could potentially trigger a massive wave of litigation against the IRS for their failure to process claims in a timely manner. Therefore, the IRS is likely to seek settlements to avoid the risks of a negative ruling, making now an ideal time to pursue legal action.
Favorable Legal Environment
Based on the facts, we believe many businesses were significantly impacted by government orders during the COVID-19 pandemic. If COVID-related restrictions affected your business, you likely qualify for some measure of ERC relief. Given the broad nature of the relief program and the mounting challenges to the IRS’s interpretation, impartial federal judges are likely to side with plaintiffs who can demonstrate the pandemic’s impact on their operations.
Jury Trial Option and Faster Settlements
In federal district court, you have the option of having your case decided by a jury, providing a layer of impartiality that can be beneficial for your claim. This is especially important given the intense scrutiny the IRS is facing over its handling of ERC claims. Additionally, the government’s current predicament suggests that the DOJ Tax Division may be more inclined to settle cases quickly, especially if litigation trends continue to favor businesses. With this in mind, we believe the time is right for our clients to be proactive, press their claims, and potentially secure the refunds they’re entitled to faster than waiting for the IRS to act.
How to Get Started with an ERC Lawsuit
If you’ve been impacted by the IRS’s delays or denials of your Employee Retention Tax Credit claim, now is the time to take action. With the IRS facing significant challenges in managing these cases, pursuing legal action could be your best chance to secure the refund you deserve. By bringing your case to federal court, you remove the decision-making from the hands of the IRS and place it in the hands of a neutral federal judge. This can expedite the process and increase your chances of success. Our team is here to guide you through the legal process, assess your case, and help you navigate the complexities of an ERC lawsuit. To learn more about our ERC Litigation service, visit our service page.
Contact us today to schedule a consultation and take the first step toward recovering your ERC refund.