New ERC Cutoff in “One Big Beautiful Bill” Runs into Serious Parliamentary and Constitutional Headwinds

The House reconciliation measure branded the “One, Big, Beautiful Bill” (OBBB) would bar the IRS from paying any Employee Retention Credit (ERC) refund claims filed after January 31, 2024. Section 112205 of OBBB also imposes stiff penalties on ERC “promoters.” The ERC-related provisions in OBBB are vulnerable to procedural challenges in the Senate and, if enacted, to constitutional challenges in the courts. The Senate’s “Byrd Rule” could prevent the retroactive repeal provisions in OBBB from being enacted. If enacted, retroactive repeal of the ERC may run afoul of the Fifth Amendment’s restrictions on retroactive legislation. The provisions in OBBB permitting the IRS to assess penalties on ERC “promoters” based on a failure to comply with standards that did not exist also raise Fifth Amendment concerns. If these penalty provisions are enforced by the IRS, we expect challenges based on the claim that administrative enforcement of these penalties violates the Seventh Amendment right to a jury trial. 

Retroactive Repeal of the ERC Is Vulnerable to a “Byrd Rule” Challenge in the Senate

OBBB is a reconciliation measure. The Senate can pass reconciliation legislation with a majority of votes, rather than the 60 votes required for other legislation. The Senate’s “Byrd Rule” prohibits reconciliation legislation from including “extraneous matters.”^[1] An extraneous matter includes recommendations with respect to the old-age, survivors, and disability insurance program (i.e., Social Security). The version of the ERC enacted via the CARES Act and extended in the 2020 Consolidated Appropriations Act applies to ERC refund claims from the second quarter of 2020 through the second quarter of 2021. For these periods, the ERC is a refund against Social Security taxes.

The American Rescue Plan Act extended the ERC to the third and fourth quarters of 2021.^[2] Because the American Rescue Plan Act was passed via reconciliation, the ERC for the third and fourth quarters of 2021 is a refund against Medicare tax, rather than Social Security taxes. The Byrd Rule does not specifically identify legislation affecting Medicare tax as an extraneous matter.

Because the ERC from the second quarter of 2020 through the second quarter of 2021 implicates Social Security taxes, we expect that a Byrd Rule objection will be raised in the Senate. The Senate parliamentarian may rule that this portion of OBBB is extraneous and cannot be included in the bill. The provision would then be stricken from OBBB unless it garners 60 votes in the Senate.

Retroactive ERC Denial Raises Fifth Amendment Concerns

The provisions in OBBB that bar the IRS from paying ERC refund claims filed after January 31, 2024, first appeared in H.R. 7024, legislation that passed the House of Representatives by a wide margin in January 2024, but died in the Senate. OBBB is resurrecting this legislation 16 months later. While the IRS had an informal moratorium on processing ERC refund claims filed after January 31, 2024, it has since paid some of them. Some businesses that filed ERC refund claims after January 31, 2024, have initiated refund lawsuits in federal court to compel payment of their claims. Businesses whose ERC refund claims have been pending for at least six months can file refund lawsuits in federal district court or the Court of Federal Claims.

The Due Process Clause of the Fifth Amendment to the U.S. Constitution protects individuals and businesses from being deprived of “life, liberty, or property, without due process of law.” A key aspect of the Due Process Clause is preventing retroactive legislation that is “particularly harsh and oppressive.”^[3]

Only in rare instances has Congress passed retroactive tax legislation. The Supreme Court has stated that the period of retroactivity for tax legislation must be “modest” and “supported by a legitimate legislative purpose furthered by rational means.”^[4] In United States v. Carlton, the Supreme Court rejected a taxpayer’s Due Process challenge to a retroactive elimination of an estate tax deduction. The Court noted that the retroactive change was a “technical fix” to a legislative oversight and had a modest retroactive period of one year.

The ERC provisions in OBBB would have a retroactive effect of more than 16 months. The provisions establish substantive changes, not a simple technical fix. OBBB would eliminate pending refund claims, and for some taxpayers who have received refund checks, the legislation would allow the clawback of refunds that were already issued. While the status of a filed refund claim as a property interest protected under the Due Process Clause is uncertain, a refund check issued to a taxpayer likely is a protected property interest. If a taxpayer has commenced a refund lawsuit with respect to a claim filed after January 31, 2024, the taxpayer might have a stronger argument that the Congress cannot legislatively eliminate the basis for the taxpayer’s suit.

ERC Promoter Penalties Raise Fifth and Seventh Amendment Concerns

The ERC “promoter” penalties in Section 112205 of OBBB apply retroactively to penalize conduct occurring after March 12, 2020. The promoter penalties implicate both the Fifth Amendment’s Due Process Clause and the Seventh Amendment’s right to a jury trial.

Section 112205 of OBBB retroactively establishes documentation requirements for persons assisting with ERC refund claims. Failure to comply with documentation requirements that did not exist when the ERC refund claim was filed could result in per-claim penalties of $1,000, and penalties of up to 75 percent of the gross income the person derived from providing assistance with respect to an ERC refund claim. The IRS has authority to assess these penalties administratively.

OBBB establishes new penalties based on a failure to comply with retroactive standards. The Supreme Court in Carlton stated that a retroactive tax statute could be struck down if it creates a “wholly new tax.”^[5] While the ERC promoter penalties are engrafted into existing sections of the Internal Revenue Code, they would likely be considered a “wholly new tax” for Due Process Clause purposes.

The Supreme Court’s June 2024 decision in SEC v. Jarkesy^[6] eliminated the SEC’s ability to assert securities fraud penalties through administrative proceedings initiated by the SEC. The Court held that the SEC’s assertion of penalties violated the Seventh Amendment’s jury trial guarantee.

The ERC promoter penalties, like most penalties in the Internal Revenue Code, are assessed by the IRS. There is no right to a jury trial unless the penalty is first paid, and the taxpayer sues for a refund. Since the Supreme Court’s decision, taxpayers have raised the Jarkesy decision as a defense against civil tax penalties. The Fifth Circuit recently held that civil penalties enforced by the Federal Communications Commission (FCC) violated the Seventh Amendment because the penalized telecommunications provider had no right to a jury trial.^[7] If the ERC promoter penalties in OBBB are enacted and enforced by the IRS, a Seventh Amendment challenge is likely.

Looking Ahead

The Senate parliamentarian will vet numerous aspects of the reconciliation legislation. We expect Senators to raise points of order with respect to the ERC provisions in the bill. If the ERC provisions overcome the procedural obstacles in the Senate, constitutional challenges loom.