The employee retention credit (ERC) has been a thorn in the IRS’ side for some time. Enacted during the COVID-19 pandemic, Congress originally designed the ERC as a means to funnel much needed money to eligible businesses that retained, rather than laid off, their employees. At first blush, the qualifications for the ERC seem simple: employers who meet either a gross-receipts test or a governmental order test initially qualify. However, complexities in interpreting the second test and other restrictions on the credit have made implementation of the ERC more difficult.
Nevertheless, the ERC turned out to be widely popular, even after COVID-19. By September 14, 2024, the IRS indicated that it was receiving more than 17,000 ERC claims a week, adding to an inventory of roughly 1.4 million pending and unprocessed claims. Given the logjam, it was not unusual for employers to complain of long wait times. In some instances, employers were waiting more than two years since the ERC claim was filed for their refunds.
But given a recent announcement, the IRS may be catching up. On October 10, 2024, the agency announced that it was currently processing roughly 400,000 ERC claims, representing $10 billion of credits. The announcement came with further good news for eligible employers: the agency also indicated that refund checks were being mailed for qualifying claims “with more planned in the weeks and months ahead.” Although the IRS no doubt has more work to do to catch up, it appears to be moving in the right direction in processing more ERC claims.
This progress may be right on time. Under federal tax law, a taxpayer may file a lawsuit against the government for unpaid refunds, including the ERC. To file suit, the taxpayer must wait at least six months to provide the government with time to review the refund claim (unless the government denies it prior to the six month period). Because of the large backlog of ERC claims, many employers are eligible to file refund lawsuits now against the IRS. And, many recently have. See, e.g., MTH Enterprises v. U.S., No. 24-cv-9729 (N.D. Ill. Oct. 8, 2024) (complaint for $1.3 million ERC refund); Kenjya-Trusant Group LLC v. U.S., No. 1:24-cv-02592 (D. Md. Sept. 6, 2024) (complaint for $3.5 million ERC refund); Miss Marta’s Inc. v. U.S., No. 7:24-cv-00900-FL (E.D.N.C. Sept. 26, 2024) (complaint for $400,000 ERC refund).
In the last year, I have had multiple discussions with employers regarding whether they should file a lawsuit or wait for the IRS to process the ERC claim. Ultimately, many considerations come into play in weighing these options, including the amount of the ERC refund, the employer’s financial position, and the strength of the ERC claim. Employers often express frustration with the IRS processing system, although they also express concern with delaying their ERC refund further by filing a lawsuit. If the IRS happens to be close to processing their ERC claim administratively, these employers do not want to wait longer for the litigation process to play out. These are valid concerns because litigation often does take time to resolve.
Another ERC lawsuit I spoke about some time ago provides a good illustration of this point. On January 12, 2024, Polk Mechanical filed an ERC refund lawsuit in the Northern District of Texas. See Polk Mechanical Co. LLC v. U.S., No. 4:24-cv-00049 (N.D. Tex.). According to its complaint, the company seeks over $3 million in ERCs under the gross-receipts test. Based on that case’s docket history, the parties have not reached a resolution on the ERC claims as of October 10, 2024, i.e., approximately nine months since Polk Mechanical filed its complaint.
The parties filed a joint report with the court on April 5, 2024. The report provides some of the concerns the government appears to have with Polk Mechanical’s ERC claims:
Plaintiff must substantiate its claim for refund for the ERC for each period to prove its entitlement to the refunds . . . To determine whether plaintiff is entitled to the ERC, discovery will be focused on whether (1) the plaintiff experienced a decline in gross receipts, (2) the plaintiff is part of an aggregated group, (3) the plaintiff claimed the ERC for wages paid to related individuals, and (4) the plaintiff claimed the ERC for wages it used for paycheck protection program loan forgiveness.
Significantly, the scheduling order suggests that discovery will conclude in Polk Mechanical on January 17, 2025. In many cases, the conclusion of the discovery period can provide the impetus for settlement negotiations as both sides have relevant evidence produced through discovery and may now weigh their strengths and weaknesses. Therefore, it would not be surprising if the case settled after discovery closes on January 17, 2025. Nevertheless, if the parties are unable to reach a settlement, they are scheduled for a jury trial starting on June 16, 2025.
Polk Mechanical was one of the earlier ERC lawsuits. Accordingly, it provides some good insights to employers who are on the fence on whether to file an ERC lawsuit. Initially, it shows that the government will question the validity of the employer’s ERC refund. Moreover, that case demonstrates that it may take some time to convince the government on the validity of an ERC claim. As mentioned above, Polk Mechanical involves the much easier computational gross-receipts test. Employers who claimed the ERC under the more nebulous governmental order test should therefore expect more difficulties and delays in proving their claims. At a minimum, employers who choose to file suit should ensure they have a valid assessment of their claim from a tax professional who can explain the potential risks and rewards in filing suit against the government prior to actually doing so.
Finally, another important takeaway from Polk Mechanical is that although the company may have to wait 17 months for resolution of its ERC claim (assuming the case makes it to trial on June 16, 2025), its decision to file suit does not necessarily mean it made the wrong move. If the company had chosen not to file suit, there would still be a good chance that it would be waiting for the IRS to act on its refund claim similar to thousands of other employers. To the extent Polk Mechanical wanted more certainty and control over its ERC claims, the company may be quite happy where things stand currently—it can see the end in sight.
Thus, employers must think carefully in determining whether they should file an ERC lawsuit. Although the IRS’ recent announcement of refunds is promising to many employers, others who do not receive a refund in this processing round will have to continue to wrestle with whether litigation is the right move for them.
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