The employee retention credit (ERC) has been a hot topic lately in the tax world. On September 14, 2023, the IRS imposed an administrative moratorium on processing ERC claims, citing rampant fraud. Later, the IRS enacted various disclosure programs designed to permit employers to either withdraw their ERC claims, if they had not received an ERC refund, or pay back the ERC, if an ERC refund had already been issued. More recently, a congressional committee has hinted that Congress may attempt to step in and bar future ERC claims altogether.
The IRS' heightened scrutiny of ERC claims—although mitigating against fraud—has caused challenges to employers with legitimatepending claims. According to a recent National Taxpayer Advocate (NTA) report, "[e]mployers who file eligible ERC claims are often waiting six months or longer to receive their [ERC] credits or refunds." And under existing law, this wait can be even longer. Indeed, as noted by the National Taxpayer Advocate in her 2024 Purple Book, "[u]nder current law, there is no requirement that the IRS pay or deny [claims for credit or refund]. It may simply ignore them."
But employers are not left without options. As shown in a recent filing in the Northern District of Texas in a case styled Polk Mechanical Company, LLC v. United States, Case No. 4:24-cv-00049 (N.D. Tex.), employers who meet certain requirements may file a lawsuit against the government if the IRS takes too long in reviewing an ERC claim.
The Original Complaint in Polk Mechanical was filed on January 12, 2024. According to the allegations in the complaint, the company—Polk Mechanical Company, LLC (Polk Mechanical)—hired, among others, heating, ventilation, and air conditioning (HVAC) workers to provide services to its customers in Texas and surrounding states during COVID-19. The company filed an original employment tax return (Form 941) for its first quarter of 2021 which did not claim the ERC. Later, Polk Mechanical determined that it qualified for the ERC and filed an amended return (Form 941-X) for this quarter, claiming over $3 million of refundable ERCs.
The company mailed the Form 941-X to the IRS on January 28, 2022. The complaint suggests that the IRS acknowledged receipt of the Form 941-X, notating in its administrative transcripts that it was "forwarded for processing" on February 11, 2022. Almost two years later, though, the IRS had failed to issue the refund or otherwise make a formal determination on the company's ERC eligibility for this quarter.
The IRS' failure to act caused significant filing pains for Polk Mechanical in later employment tax years. Specifically, the company attempted to utilize the refundable ERC from its first quarter of 2021 to reduce its reported employment taxes for its first and second quarters of 2022. The IRS processed the returns but refused to allow the company a credit for the refundable ERCs for these periods, resulting in roughly $2 million of penalties, interest, and fees. This $2 million was on top of the more than $3 million of refundable ERCs that were never credited or paid to the company for its first quarter of 2021.
Accordingly, the Original Complaint seeks over $5 million of ERCs, penalties, and interest from the government under section 7422 of the Internal Revenue Code (Code). That provision allows a taxpayer to file a lawsuit against the government for any "erroneously or illegally assessed or collected" taxes, but only if the taxpayer satisfies certain requirements. Those requirements include fully paying the taxes at issue, filing a valid administrative refund claim with the IRS, and giving the agency sufficient time to review the merits of the claim. For these purposes, sufficient time means that the taxpayer must wait until the IRS formally disallows the claim or, alternatively, if the IRS fails to act on the claim at all (which seemingly occurred here), the taxpayer waits at least six months from the date the claim is filed to file suit. Taxpayers who fail to satisfy these requirements risk having their entire case tossed out of court for lack of jurisdiction.
The government has not filed an answer to the Original Complaint, but the benefits to Polk Mechanical in filing a lawsuit are clear. First, the filing effectively transfers responsibility of the case from the IRS to the Department of Justice Tax Division (DOJ-Tax). The company will have an opportunity to discuss the issues of the case with a DOJ-Tax attorney. Second, and unlike the IRS, DOJ-Tax may not wait forever in acting on the ERC claim—rather, it will be subject to scheduling orders and court review to ensure that the case moves forward expeditiously. DOJ-Tax may ultimately disagree with the company that it is entitled to the ERC claim, but it must do so under the watchful eye of the court.
In sum, Polk Mechanical serves as a good reminder that taxpayers are not at the mercy of the IRS' indecision or inaction. Instead, taxpayers may elect to file a lawsuit against the government to force the government to show its hand. However, employers in the ERC context need to be careful prior to filing a lawsuit. Given the complexities of the ERC, these employers will want to ensure that they meet the requirements of the ERC and that there are no lurking risks to them in filing the complaint. Moreover, because the claim for refund and filing requirements are technical, employers should consult with a tax professional prior to filing suit to ensure compliance with Section 7422 of the Code.
Originally published by Forbes.
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