IRS Lawsuit Sparks Fears: Are Tax Refunds Facing Extinction?

A growing number of Americans are suing the US Internal Revenue Service for millions in Employee Retention Credit (ERC) tax refunds, snowballing in the process. In fact, dozens of lawsuits are seeking compensation for promises that weren’t kept during the COVID-19 pandemic.

What’s the problem with the Employee Retention Credit?

The EFC was intended by Congress as an incentive to keep eligible businesses from laying off staff during the COVID-19 pandemic in exchange for them retaining staff. The criteria to qualify initially seemed simple: The test required employers to meet either a governmental order test or a gross receipts test. Interpretations of the governmental order test have created a spanner in the works. Additionally, the credit is restricted.

By September 2024, the IRS reported that 17,000 claims were being received every week, a backlog of 1.4 million unprocessed claims, and by the end of that year the backlog had grown to 8 million. Two years after filing a claim, some employers said theirs were still unattended. Now, companies are receiving claim disallowance notices and being told they have no standing at all.

Companies suing the IRS over unpaid claims

A case illustrating a relevant one is an Ohio industrial staffing firm. Coronavirus restrictions had caused the company to pause hiring but it had continued with paying its employees, at a cost of $5 million, on the assumption the IRS would deliver on its promise. They’re now taking legal steps to recoup themselves. A similar situation involving a North Carolina childcare center sought $394,000.

As the IRS piles up a bigger headache than just an ERC admin backlog, its cases over those tax refunds are growing steadily. They’ve also accepted that some claim disallowance letters were wrongly issued, leading to some embarrassment for the federal body.

Promoters hypermarketed getting easy access to money, hype that led to a lot of claims, and far too many false or false claims have eaten away at the 1.4 million backlog of claims.

IRS offers reasons for unforeseen complications

Deputy Commissioner Douglas O’Donnell of the IRS, under pressure from the lawsuits piling up, offered some explanations for the incredibly long delays: we expected a volume of claims that could reasonably be dealt with, most of which are simple enough—but are suffering from an unexpectedly large volume of claims, many of which are unclear or illegible, some much more complex than others, and an overall requirement to bring on additional staff just to deal with the volume of admin.

What’s the current situation with the IRS and unpaid ERC claims?

After a year of halting the process to regroup and develop an approach, the Internal Revenue Service has picked up the pace, resuming work on the claims. There’s still a long way to go, however. With its attempt to address some problems, among other things, it allows employers to use the Voluntary Disclosure Program to fix any false or inaccurate statements in the claims.

Not all businesses, however, are pleased. There has been no basic information of the status of claims, like acknowledgment of delay or notice of disallowance.

The tax agency, however, says it is processing 400,000 of the 1.4 million unprocessed ERC claims. Some checks have already gone in the mail and they’ve been worth around $10 billion.

Should you file a lawsuit against the IRS over an unpaid ERC claim?

Here are points to consider before initiating legal proceedings against the Internal Revenue Service:

• According to federal law, a taxpayer can sue the government to get back unpaid refunds.
• The government then has six months to look at the claim, and the taxpayer has to allow this.
• The employer can legally challenge a claim as soon as it has been denied without waiting for the six-month period to be up.
• Those factors include the strength of the claim, the amount of the claim and the employer’s financial fortitude to take on legal costs.
• You will be sent notification of your claim denial within 30 days, after which you have two years to pass up the appeal or file your suit.

Clearly the IRS is reading the room and addressing the Employee Retention Credit debacle, hopefully with a speedy check in the mail instead of diving up the legal road and complicating an already unplanned issue.

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