Taxpayers have options for appealing disallowed ERC claims

The IRS is stepping up its review of the agency’s backlog of unprocessed employee retention credit (ERC) claims, which has resulted in a large number of claims being accepted or disallowed in the past few weeks. Unfortunately, the notices that a taxpayer’s ERC claim has been disallowed did not clearly explain the reason for the disallowance or the steps that should be taken to appeal the IRS’s decision.

While the IRS has been disallowing ERC claims in bulk, taxpayers who believe their ERC claim was incorrectly disallowed have options for appealing the agency’s determination. Unfortunately, as explained below, the process for appealing a disallowed ERC claims is more complicated than it is for most disallowed refund claims.

Some qualifying ERC claims reportedly denied

The IRS has been concentrating on processing the “low-hanging fruit” of ERC claims where the agency could easily decide whether a claim should be allowed or disallowed, but the Taxpayer Advocate Service (TAS) has received complaints from some tax preparers regarding disallowed claims should have qualified for the ERC. The IRS claims to have an accuracy rate of more than 90% when it comes to processing claims, but that still means that up to 10% of correct claims may be disallowed. Additionally, the IRS has acknowledged that the disallowance letters did not clearly explain the taxpayer’s options for appeal and planned to send follow-up letters to affected taxpayers.

TAS has also been told by taxpayers and tax professionals that the IRS incorrectly explained the basis for the disallowance of their ERC claims. National Taxpayer Advocate Erin M. Collins said that the incorrect explanations may indicate a problem with the IRS’s risk-scoring filters. She added that the IRS is planning to send letters to taxpayers acknowledging that some notices contained errors and reiterating the taxpayer’s right to have the IRS Office of Appeals review the disallowance.

IRS struggled with large number of incorrect claims

The ERC was created by Congress during the COVID-19 pandemic to offer financial relief to businesses and other entities that retained employees when they were forced to shut down due to a governmental order. Unfortunately, the large amounts of money that could be claimed by the ERC made it the target of unscrupulous promoters who encouraged ineligible taxpayers to file ERC claims.

After being overwhelmed with questionable ERC claims, the IRS placed a moratorium on processing new claims in September 2024. The IRS recently announced that it will begin reviewing claims filed from Sept. 14, 2023, through Jan. 31, 2024. It also announced that it has sent out 28,000 disallowance letters in recent weeks to businesses that have made ERC claims with a high likelihood of being incorrect. The agency is continuing to review claims and disallow claims made by taxpayers with a high likelihood of being ineligible for the ERC.

Appeals process differs from other refund claims

The process the IRS uses to determine that a taxpayer’s ERC claim should be disallowed is different from the procedures the agency usually uses in evaluating refund claims. In most situations the disallowance follows an audit of the claim where the taxpayer has the opportunity to support their claimed refund. But when the IRS disallows ERC claims, it uses a risk-scoring analytic process. If the IRS’s analytics determined there was a high risk that a claim was incorrect, it is disallowed.

The process for appealing disallowed ERC claims is also distinct from the process for other disallowed refund claims. Usually, when a taxpayer disagrees with the IRS’s disallowance of a refund, they can appeal to the IRS’s Independent Office of Appeals within 30 days of receiving notice of the disallowance. However, when a taxpayer appeals the disallowance of their ERC claim, their response is usually reviewed by the IRS and then sent to a revenue agent for consideration. Based on the revenue agent’s findings, the IRS can allow the claim, request additional information from the taxpayer or reject the claim based on its review of all available documentation. It is only after this review that the taxpayer’s claim is sent to Appeals.

The IRS is still finalizing its process for notifying a taxpayer that their case has been reviewed and passed on to Appeals. Collins recommended that the notice include a detailed explanation of the basis for the disallowance and offer taxpayers the opportunity to respond to issues or questions identified during the IRS’s review process along with a deadline for doing so.

Appeals process expected to be lengthy

Collins warned taxpayers filing appeals of ERC claim denials that the process will likely be lengthy. That’s because it will involve an IRS review of the taxpayer’s facts and circumstances. It will likely take several months or more for the IRS to complete its review of the taxpayer’s case before it is forwarded to Appeals. It can take Appeals five months or more to hold an initial conference with a taxpayer.

When choosing to file an appeal with the IRS, taxpayers need to keep in mind that they only have two years from date on the notice they receive that their ERC claim has been disallowed to file a lawsuit or be issued a refund. The IRS can’t issue a refund more than two years from the date on the first page of the notice of disallowance. As a result, even if a taxpayer has their case heard by Appeals and it sides with the taxpayer, they may lose their right to a refund.

Going to appeals does not, by itself, extend the two-year period for refunds or court action. But if the taxpayer and IRS reach an agreement and sign Form 907, Agreement to Extend the Time to Bring Suit, the time may be extended.

Taxpayers who qualify may want to request an ‘Appeals Fast Track’, but there is a question as to whether taxpayers responding to a batch of ERC disallowance notices will qualify. With Fast Track, an independent mediator from Appeals tries to help the taxpayer and IRS reach an agreement on disputed issues and may propose settlements. Because taxpayers who appeal the disallowance of their ERC claim will be subject to an exam-like review, Collins said those taxpayers may be disqualified from using Fast Track.

Federal court is still an option

Taxpayers whose ERC claims were disallowed also have the option to file a lawsuit in their federal district court or the U.S. Court of Federal Claims. Taxpayers can file a federal court lawsuit within two years of receiving notice of their claim being disallowed, regardless of whether they have appealed the disallowance within the IRS.