Preserving the limitation statute for ERC claims

Under normal IRS procedures, filing a written protest contesting a disallowance gets a case in front of an IRS Appeals officer for consideration. After all, the IRS has disallowed the claim at this point; the protest, by its terms, requests review by Appeals.

However, due to unique approaches the IRS has been taking in processing ERC claims, some of these protests disputing claim disallowances may never make it to Appeals. In the National Taxpayer Advocate’s Annual Report to Congress for 2024, the taxpayer advocate identified ERC processing delays as the No. 1 most serious problem encountered by taxpayers in dealing with the IRS. The report states that the IRS has largely abandoned its standard exam procedures in favor of compressed, cursory reviews that, for reasons that will be discussed, in some circumstances risk causing the taxpayer to run into the expiration of the statute of limitation on refunds. Specifically, the report notes that in summer 2024, the IRS issued 28,000 notices of claim disallowance (typically, Letter 105-C) after running ERC claims through its risk scoring model analysis. When a taxpayer responds to the ERC Letter 105-C, the report states, the IRS will conduct an audit-like review process prior to sending the case to Appeals.

The report refers to this approach as a “reverse audit-like process,” a fitting description. After confusion among the public in how to respond to these notices, the IRS published guidance on its webpage noted above, “Understanding Letter 105-C, Disallowance of the Employee Retention Credit.” This page provides a detailed list of what to send the IRS in response if the taxpayer disagrees with the disallowance. It includes such items as documentation of eligibility and business records to document gross receipts for all quarters of the year of the claim — similar to what would be requested in a standard examination of an ERC claim.

One of the problems with this reverse audit-like process, as pointed out by the taxpayer advocate’s report, is that, under the IRS’s own procedures, the taxpayer’s protest cannot go directly to Appeals. Instead, the response and documentation submitted must be reviewed by the Service first. Appeals is not a finder of fact and cannot review documentation that an Examinations employee has not yet considered, so the protest, with its supporting documentation, cannot go directly to Appeals. Instead, it is likely going into a stack at an IRS processing center to be reviewed by an IRS employee at some point. Obviously, this further compounds the delays taxpayers have already been experiencing related to ERC claims.

Reverse-audit process puts taxpayers’ claims at risk due to statutory limitations on refunds

The report states that the IRS is subjecting taxpayers to this reverse audit because it first issues a notice of disallowance and then asks the taxpayer to substantiate their claim, instead of taking the traditional approach, where the IRS examines the claim, then proposes a disallowance. In those traditional cases, the IRS issues a 30-day letter, allowing the taxpayer to go to Appeals before it issues the formal notice of disallowance.

This reversal of standard process makes a significant difference in the statute-of-limitation analysis because the Letter 105-C starts the running of the statute of limitation on claims for refund. Sec. 6514(a)(2) provides that a refund of any tax shall be considered erroneous if made after the expiration of the period of limitation for filing suit for a claim the IRS has disallowed, unless the taxpayer began a suit within that period. Sec. 6532(a) provides that no suit can be filed for the recovery of tax after the expiration of two years from the date of the mailing by certified or registered mail of a notice of disallowance. For further discussion of this issue, see Solodchikova and Brady, “Issuance of Tax Refund After Expiration of Sec. 6532 Time Limit,” 52 The Tax Adviser 223 (April 2021).

Taxpayers who go through a standard examination can go to Appeals before the two-year refund statute of limitation starts to run. For those taxpayers who received an ERC Letter 105-C under the reverse audit-like process, or because they failed to respond timely to an IRS request for substantiation of their claim in a streamlined IRS audit — a process also discussed in the report — the two-year clock starts running well before they get their foot in the door with Appeals.

The two-year clock is not a secret, but it is often overlooked. Because it is not detrimental to the government to let this statute pass, the IRS does not take proactive steps to stop it from expiring, so it is up to individual taxpayers to monitor the running of this statute. Discussion of the two-year limitation is found within the text of the Letter 105-C. It is also discussed on the IRS webpage referenced above, which states:

Two-year timeline

Generally, you have two years from the date of Letter 105-C (your original claim disallowance) to file suit. Requesting an appeal doesn’t extend this time.

By law, we can’t issue a refund or allow a credit after the two-year period unless you file suit during that period. If the end of the two-year period is approaching and a decision hasn’t been made on your appeal (or if a favorable decision was made but the refund hasn’t been paid yet), you can file suit or discuss extending the two-year period with us to protect your ability to receive a refund.

If you don’t file suit within the two-year period or sign an agreement with the us [sic] extending the two-year period to file suit, you may lose your ability to receive a refund, even if Appeals has already made a favorable decision about your claim.

The IRS and a taxpayer may extend the time to file suit by written agreement (Form 907, Agreement to Extend the Time to Bring Suit), which needs to done before the two-year period expires.

Securing a statute extension to protect the refund beyond the two-year period

The IRS webpage on Letters 105-C thus sets out the two options taxpayers face with the expiration of the two-year period of limitation: (1) file a refund claim suit or (2) secure a statute extension. The IRS form for extending this period of limitation is Form 907, as previously noted. It is relatively straightforward and easy to complete from the taxpayer’s perspective. The challenge is securing a countersignature from the appropriate individual at the IRS. Form 907 provides the following instructions to IRS employees:

Complete the Division Executive’s name and title depending upon your division.

If you are in the Small Business/Self-Employed Division, enter the name and title for the appropriate division executive for your business unit (e.g., Area Director for your area; Director, Compliance Policy; Director, Compliance Services).

If you are in the Wage and Investment Division, enter the name and title for the appropriate division executive for your business unit (e.g., Area Director for your area; Director, Field Compliance Services).

If you are in the Large and Mid-Size Business Division, enter the name and title of the Director, Field Operations for your industry.

If you are in the Tax Exempt and Government Entities Division, enter the name and title for the appropriate division executive for your business unit (e.g., Director, Exempt Organizations; Director, Employee Plans; Director, Federal, State and Local Governments; Director, Indian Tribal Governments; Director, Tax Exempt Bonds).

If you are in Appeals, enter the name and title of the appropriate Director, Appeals Operating Unit.

The signature and title line will be signed and dated by the appropriate authorized official within your division.

The Internal Revenue Manual (IRM) at Section 4.10.11.2.16.1.1(7) provides that directors are authorized to execute Form 907. The authority has been redelegated in some IRS divisions. But how does one find these people and request they agree to sign the Form 907? The only method available to taxpayers who do not have a contact in IRS Examination or Appeals is to file a request for assistance from the Taxpayer Advocate Service (TAS), using Form 911, Request for Taxpayer Advocate Service Assistance, and once it is assigned, request that the advocate help secure a countersignature on Form 907. IRM Section 4.10.11.2.16.1.1(8) provides that TAS uses Form 12412, Operations Assistance Request, to request assistance from IRS operating divisions to secure Form 907 signatures when dealing with an imminent Sec. 6532 statute.

The IRM provision points out that requests from TAS to extend the Sec. 6532 statute are subject to careful consideration, but IRM Section 4.10.11.2.16.1.1(5) provides that one example of a satisfactory reason for an extension is where “an extension will prevent possible inequities to taxpayers (e.g., the taxpayer is entitled to a refund but additional processing time is needed to issue it prior to the IRC 6532 statute expiring).” Under the circumstances surrounding ERC Letters 105-C, especially those relating to reverse-audit-like procedures, the IRS should be willing to agree to an extension to avoid inequities to taxpayers. Still, ample time must be allowed for requesting the assistance of TAS and securing the assignment of an advocate, as well as for completing, processing, and securing signatures on a Form 907. Therefore, taxpayers who have received an ERC Letter 105-C and responded with a formal protest but have not yet received a response would be wise to consider starting the process to secure a statute extension well before the expiration of two years from the Letter 105-C issuance date.

Practitioners should be aware that Letters 106-C, Claim Partially Disallowed, will cause taxpayers to face similar issues related to the statute of limitation on refunds. The IRS has published a similar informational website on these ERC-related partial disallowance letters. Additional, reader-friendly discussion of ERC disallowance letters, statutes of limitation, and taxpayer rights can be found in this blog published by the taxpayer advocate. As always, practitioners should be aware of their obligations under Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), including the duty of competence in Section 10.35 and best practices in Section 10.33, which include clear communication and advising clients regarding the import of conclusions reached.

— Marissa Lenius, J.D., is a senior manager in the tax controversy group in RSM US LLP’s Washington National Tax Practice. To comment on this article or to suggest an idea for another article, contact Paul Bonner at Paul.Bonner@aicpa-cima.com.