The IRS has now given taxpayers two years to protest a disallowance letter related to the Employee Retention Credit (ERC), following calls from the National Taxpayer Advocate and other tax professionals, and announced in a new webpage published September 19, 2024. This two-year window is an extension of the typical 30-day administrative deadline to file a protest with the IRS Independent Office of Appeals (IRS Appeals).
Generally, when the IRS reviews a claim for refund, the process begins with an examination agent, who conducts an audit. If the examination agent is not satisfied with the taxpayer’s claim, then a disallowance letter may be issued. The taxpayer has two years from the date of the disallowance letter to bring suit in U.S. District Court or the U.S. Court of Federal Claims. But, the taxpayer typically has only 30 days to file a protest with IRS Appeals. IRS Appeals reviews the claim, assesses the taxpayer’s arguments, weighs the IRS’s hazards of litigation, and attempts to settle the claim.
For ERC claims, the IRS’s normal process has been upended. Instead of conducting an audit, the IRS is disallowing claims based on internal analytics performed on a large volume of claims. The taxpayer now has two years to file a protest with IRS Appeals or file a lawsuit. The protest is sent first to an examination agent, who conducts a review much like an audit. If the examination agent concludes that the ERC claim should be allowed, then the IRS will process the claim. However, if the examination agent concludes that the ERC should still be disallowed and the protest specifically requests an appeal, then the protest is sent to IRS Appeals. The taxpayer’s response must request an appeal to be forwarded to IRS Appeals, otherwise the IRS will not forward the protest following its determination. Meanwhile, the two-year window to file suit continues to run.
Taxpayers who receive a disallowance letter related to an ERC claim should consult a tax professional to evaluate their options. Once a disallowance letter is received, the taxpayer is no longer eligible for the second Voluntary Disclosure Program or the claim withdrawal program, which are the IRS’s two processes for unwinding a potentially erroneous ERC claim. Instead, the taxpayer must decide whether to continue the claim or accept the IRS’s disallowance, which may merit a comprehensive review of the claim itself and supporting documentation.
If continuing the ERC claim, then the IRS has requested that the taxpayer’s protest include, first, an explanation and documentation addressing the IRS’s reason for disallowing the claim. So, if the disallowance letter indicates that the claim has been disallowed because IRS records indicate that the taxpayer did not file Forms W-2 during the period in which the ERC was claimed, then the protest should include an explanation and documentation supporting the fact that the taxpayer had employees, filed W-2s, and paid qualified wages.
Additionally, the IRS requests documentation supporting how the taxpayer meets one of the eligibility tests for claiming the ERC in each quarter that the taxpayer claimed the credit. This means that the taxpayer must provide evidence for each quarter showing that it either (a) experienced a significant decline in gross receipts, or (b) experienced a full or partial suspension of operations due to a COVID-19 order from an appropriate governmental authority. For the third and fourth quarter of 2021, the taxpayer could show that it met the criteria for a recovery startup business.
Finally, the IRS requests a written explanation explaining why the taxpayer is entitled to the ERC, a description of the taxpayer’s trade or business operations, workpapers used to compute the ERC, a statement confirming that the ERC calculation does not include wages (i) paid to related individuals, (ii) already reported for the purposes of Paycheck Protection Program (PPP) loan forgiveness, or (iii) to employees providing services (for large eligible employers).
The requirements imposed by the IRS on an ERC protest are complex. Taxpayers looking to appeal a disallowance letter should always consult with a tax professional to ensure the documents and explanations provided to the IRS are complete and accurate.
