Many businesses and nonprofit organizations that filed employee retention credit (ERC) refund claims received refund claim denial letters from the IRS; the first wave of these letters was issued in July and August 2024. This alert discusses the key deadlines and procedures that organizations should understand when evaluating whether to file a refund lawsuit, including applicable statutes of limitations.
The Two-Year Deadline Under Section 6532
The IRS's issuance of a notice of disallowance (i.e., a denial letter or a 105C Letter) starts a two-year statute of limitations under Section 6532 of the Internal Revenue Code. The IRS is prohibited from issuing a refund check to the taxpayer unless the taxpayer files a refund lawsuit within two years from the date of the denial letter.
Filing a protest of an ERC refund denial with the IRS Office of Appeals does not extend the two-year deadline. Thus, even if an organization files a protest, the refund claim could become time-barred if the IRS Office of Appeals cannot process the protest within two years. Based on the volume of ERC protests and the attrition of IRS Appeals officers, many protests will not be assigned to and considered by the IRS Office of Appeals within the two-year deadline.
For organizations whose refund claims remain pending before the IRS with no denial letter issued, the two-year deadline under Section 6532 has not been triggered. However, an employer that has filed a refund claim and has not received a refund check or a notice of disallowance is permitted (but not required) to file a refund lawsuit six months after the filing of the refund claim.
Extending the Two-Year Deadline: Form 907 Agreements
The IRS has the authority to agree to extend the two-year period for filing a refund lawsuit under Section 6532(a)(2). The mechanism for doing so is Form 907, Agreement to Extend the Time to Bring Suit. When the IRS and the taxpayer execute a Form 907 agreement, the two-year deadline is extended by the period specified in the agreement, providing additional time for the parties to resolve the refund claim administratively before litigation becomes necessary.
The IRS has recently announced a streamlined process for organizations to request Form 907 agreements in the ERC refund context. While this development is welcome, organizations should be aware of several potential pitfalls.
Agreeing to extend the two-year period is within the discretion of the IRS. There is no guarantee that the IRS will agree to a Form 907 extension. If the IRS declines to execute a Form 907 agreement, the organization's only option to preserve its rights may be to file a refund lawsuit before the two-year deadline expires. Moreover, organizations should not assume the process will work smoothly or quickly, particularly given the volume of potential extension requests. Requests to extend the statute of limitations are submitted through the IRS's Document Upload Tool (DUT). Organizations that submitted responses to ERC refund claim examination requests through the DUT are well aware of its limitations.
The Possible Six-Year Deadline Under 28 U.S.C. Section 2401
A separate and less commonly discussed question involves whether there is an "outside limit" on the time to file a refund lawsuit when the IRS has not issued a notice of disallowance. The general Tucker Act statute of limitations in 28 U.S.C. Sections 2401 and 2501 provides that claims against the United States must be filed within six years after the right of action first accrues. Section 6532 contains no time limit other than the initial six-month restriction for a refund suit brought before a disallowance notice has been issued. Three district court decisions have held that the general Tucker Act six-year statute operates as an outside limit, requiring a refund suit to be filed within approximately six and a half years of the refund claim.[1] Earlier decisions from the Court of Federal Claims hold that a refund suit can be brought at any time if the IRS has not issued a notice of claim disallowance.[2] The IRS itself has adopted this position.[3] However, in refund litigation, the Department of Justice would not be bound by the IRS's position.
A strong case can be made that the comprehensive statutory framework for refund suits provided in Sections 7422, 6511, and 6532 of the Internal Revenue Code preempts the general six-year statute of limitations under the Tucker Act. Notwithstanding these authorities, organizations with ERC refund claims that have been pending for an extended period should file rather than risk battling an argument that the six-year limit applies.
Litigation Strategy Considerations
Organizations considering a refund lawsuit should keep several practical considerations in mind.
Venue. A refund suit can be filed in the U.S. district court where the employer has its principal place of business or in the Court of Federal Claims. The Court of Federal Claims is concerned exclusively with claims against the United States. The district courts hear a wide variety of civil and criminal cases.
Documenting Eligibility and Scope of Discovery. Organizations considering filing a refund suit should review the existing documentation for their refund claim and determine whether other supporting documents should be gathered in preparation for a lawsuit.
Scope of Discovery. In informal discovery or through formal document requests, the government will typically seek (1) payroll records such as payroll journals, W-2 forms, and healthcare billing invoices; (2) documentation of the government orders that caused a full or partial suspension of the employer's operations; (3) evidence demonstrating how those orders affected the employer's business activities; and (4) revenue records establishing a decline in gross receipts, such as internal financial records, financial statements, bank statements, and tax returns. Payroll data and gross receipts data should be reconciled to tax return data, and any material differences based on methods of calculating quarterly financial data and full-year tax return data must be explainable.
In cases involving aggregated groups of employers, evidence of common ownership during the period from 2019 to 2021 may be necessary. Many employers gathered and maintained this documentation in the preparation of their ERC refund claim. However, the information the government requests in refund litigation often extends beyond the documentation gathered to prepare a refund claim or the documentation produced in response to an IRS examination or IRS Appeals protest.
For organizations claiming eligibility based on a partial suspension of operations, the government may also request internal communications, operational records, and third-party correspondence reflecting the nature and extent of the suspension. Formal discovery could extend to interrogatories requiring the employer to identify the specific government orders relied upon and to describe in detail how each order more than nominally affected the employer's trade or business operations. The government may also seek depositions of company personnel with knowledge of the employer's operations during the relevant quarters, the impact of government orders on business activities, and the preparation of the ERC refund claims. Organizations that have carefully organized and compiled this documentation before filing suit will be better positioned to respond efficiently to discovery requests and to demonstrate the strength of their claims early in the litigation, which in turn could facilitate a faster resolution.
Conclusion
Organizations that have received refund denial letters should carefully evaluate the applicable deadlines and consider whether filing a refund lawsuit is necessary to protect their rights. Filing a protest with the IRS Office of Appeals does not toll or extend the two-year statute of limitations for filing a refund claim. While the IRS's new streamlined process for Form 907 extension agreements is a positive development, organizations should not assume that the process will proceed quickly enough to protect their claims. For organizations with claims that have been pending for many years without a denial letter, filing a refund lawsuit may be prudent within six and a half years of filing the refund claim.
[1] Finkelstein v. United States, 943 F. Supp. 425 (D.N.J. 1996); Wagenet v. United States, 2009 WL 4895363 (C.D. Cal. Sept. 14, 2009); Breland v. United States, 2011 WL 4345300 (N.D.N.Y. 2011).
[2] Detroit Trust Co. v. United States, 130 F. Supp. 815 (Ct. Cl. 1955); Consolidated Edison Co. v. United States, 135 F. Supp. 881 (Ct. Cl. 1955).
[3] Rev. Rul. 56-381; Chief Counsel Notice 2012-012.