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Byline by Dean Zerbe, Former Senior Counsel to the U.S. Senate Finance Committee; alliantgroup National Managing Director
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The IRS is moving forward with issuing tens of thousands of denial/disallowance letters to applicants of the Employee Retention Credit (ERC).
The letters come in two flavors – the “105-C letter” which is a notice of disallowance (and a 106-C – partial disallowance); and, a “Form 6577-C letter” – a credit recapture/(“clawback”) letter where IRS recaptures previously allowed credits and assesses them as additional tax. Taxpayers – and their CPAs – need to be eyes open about how to proceed if they receive these letters, especially given that they have tight response requirements.
As discussed below, a thorough response from the taxpayer can lead to a good result – depending on the facts. Further, taxpayers should, in some situations, consider whether they should seek repayment of any fees that they may have paid to a tax advisor for preparing/filing their ERC claim.
105-C/106-C Letter
The disallowance letter – the 105-C – states that the taxpayer’s ERC claim is denied (a 106-C letter would be a partial disallowance). The letter indicates that the taxpayers can disagree with the IRS determination by filing an appeal with the IRS Independent Office of Appeals. To make such an appeal, the taxpayer must file a protest letter with Appeals that includes a written statement of the facts for disputing the disallowance and legal citations for the law and authority that supports the Taxpayer’s position (and do so quarter-by-quarter) and the necessary documentation.
In our submissions on behalf of taxpayers, we especially focus on the government Covid order (if relevant to your ERC claim) that impacted your business – and how that order meets the requirements of ERC. We’ve had good results for taxpayers in ERC examinations by laying out clearly and succinctly the relevant facts, documents and legal analysis that show how the taxpayer qualifies for the ERC.
For example, we reviewed an ERC filing by a business that a promoter/ERC mill said would qualify for all seven quarters (a huge red flag – extremely rare for a business to qualify for seven quarters – much less north of five quarters) and a $2.1 million dollar credit. We reviewed the ERC claim and determined that the promoter had failed to take into account the interaction of PPP and FFCRA; no analysis was made by the promoter of whether there was nominal impact due to a government order. However, after our review, we did find that the client did qualify for two quarters and was eligible for ERC of $512,000. Grief and grind avoided.
Commonly, the 105-C letter requires that a response be filed within 30 days from the date of the letter (A little alarming especially since the IRS’s long delays in processing ERC claims). If the taxpayer has not responded within the 30-day letter requirement, the taxpayer can still look to filing a lawsuit in federal District Court or the U.S. Court of Federal Claims. Commonly, these suits are required to be filed within two years from the date of the 105-C letter.
It should be noted that if you receive a 105-C letter, you will not be eligible for the second IRS ERC Voluntary Disclosure Program or the ERC Withdrawal Program.
6577-C Form/Letter
The IRS has also been issuing tens of thousands of letters to businesses that the IRS believes have potentially erroneously received ERC payments. The focus of the forms/letters is the employee count – and possible mismatches of the Form 941 and ERC claims. Essentially, the IRS is saying with these letters – “we want our money back” – or prove us wrong. As the Treasury Inspector General for Tax Administration (TIGTA) noted in a recent report – that as of April, 2024 – 6577-C letters covering 22,072 tax years were sent (addressing $572.9 million in ERC payments) – resulting in 18,338 ERC claims being fully disallowed; 3,392 fully allowed, 14 partially disallowed and 328 under review. Thousands of more forms/letters have been sent since April and continue to be sent.
These 6577-C forms allow the IRS to claw back previously awarded ERC funds and also look to assess the tax previously owed and also possibly adding penalties and interest. Essentially the IRS is bypassing the traditional practice of filing an erroneous refund suit in Court – and using this procedure to reclaim refunds previously paid by issuing a normal tax assessment and using collection procedures.
Taxpayers receiving a Form 6577-C need to move promptly to file a protest to the IRS – the letters are giving 21 days (!) to respond. Similarly to the 105-C we find the best practice is to include the necessary factual, legal and documentary support for the ERC claim.
Reality Check – Does Your Business Qualify For The ERC?
Here is the sobering reality check as a taxpayer considers available options after having received one of these letters – does your business qualify for the ERC (and testing that for each quarter). Having worked and assisted thousands of companies to file and qualify for the ERC (and also representing taxpayers in ERC audits by the IRS), alliant has a very good understanding of what will or will not pass muster with the IRS. Unfortunately, far too many businesses receiving these letters from the IRS have relied on promoters for their ERC filing. Too often, these ERC promoters have not engaged in best practices as to confirming and documenting taxpayer eligibility for ERC – especially as to whether the Covid government order qualifies under ERC.
Further, CPAs and tax advisors need to bear in mind that the IRS views that tax professionals have important duties and responsibilities as it relates to their client’s filing for the ERC. Tax professionals need to exercise due diligence as to ERC filings made by their client – even if done by a third party.
I have written earlier about pitfalls and problems of ERC filings – and the IRS has also provided helpful guidance on warning signs of problems with an ERC filing. Also, the IRS’ Taxpayer Advocate put forward some useful points for taxpayers receiving the ERC letters: Did You Receive a Notice of Claim Disallowance for Your Employee Retention Credit Refund Claim? If So, Now What? – Taxpayer Advocate Service
In short, having received an ERC letter – it’s time to look in the mirror. Your business may qualify for the ERC, may partially qualify – or may, unfortunately, not qualify. But it’s vital to have a feet-on-the-ground understanding of the situation for your business as you decide how best to proceed. We’ve found that if you qualify, have good documentation, have legal support – the IRS will listen, and a good resolution is certainly possible.
Recovery Of Fees From Promoter
In our work assisting taxpayers who have received letters from the IRS on their ERC claims, we have had success in some cases in recovering fees from promoters of ERC claims. If your business has paid a promoter a fee – and you’ve received a letter from the IRS denying/clawing back your ERC claim – it may be possible that you can recover fees from your promoter (dependent on the promoters’ actions, due diligence, etc.).
Conclusion
Taxpayers who have received denials or “clawbacks” of their ERC claims need to promptly take action. Putting the IRS letter to the side, hoping it will go away, or doubling down on flawed factual and legal analysis in responding is a path that will get you nowhere – and only compound problems. Tax advisors particularly need to make certain that their clients know to reach out to them if they’ve received such letters.
Responding to the IRS with clear factual analysis, documents and legal support – reflecting the requirements of the ERC – will give taxpayers their best chance for the IRS to think again about whether the taxpayer qualifies for the ERC.
The simple fact is that in such complex tax matters as R&D and ERC – AI does not have the necessary human judgment.
And as a reminder, AI is only as good as the data provided to it by the humans. For example, I and my colleagues commonly see errors where AI just accepts a taxpayer’s response to whether a project qualifies for R&D – rather than probing and asking how the taxpayer substantiates each element of the four-part test for each project.
There is no question that the IRS – as it determines which taxpayers to audit – is highly aware of these problems of AI-generated tax returns (especially for complex matters such as R&D and ERC). I expect the IRS will be focusing its limited audit resources on AI-generated returns – both the taxpayer and the tax preparer. Fish-meet-barrel. In discussing all this with one of my colleagues, Darren Guillot, a National Director at alliantgroup and formerly Commissioner of Small Business/Self Employed at the IRS, he said: “I want to be clear, you are accepting considerable risks when relying on AI to do an R&D study.“ Eyes open.
While there is certainly a role for AI in tax preparation – especially repeatable tasks with predictable outcomes – AI cannot replace the need for informed and knowledgeable tax experts making determinations on behalf of their client. Taxpayers need to be aware – and ask questions of their tax preparer – of who is doing the actual work of their tax return and what, if any, role AI is playing. Tax advisors need to be similarly aware as to the limits of AI – given that they will be ultimately responsible for their work. Tax advisors will not be able to point to AI/software to excuse or wish away problematic results for their clients. Unfortunately, AI does not provide the easy answers for tax filing – the work still must be done.
Featured Leadership
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington D.C. office. Prior to joining alliantgroup, Mr. Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman and current Ranking Member of the Finance Committee, Senator Charles Grassley (R-IA), on tax legislation. During his tenure on the Finance Committee, Mr. Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law – including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform), and the Pension Protection Act. Mr. Zerbe is a frequent speaker and author on the outlook for short-term and long-term changes in tax policy, as well as ways accounting firms can help their clients lower their tax bill.
