Employee Retention Credits Refund Delays: Insights and Options

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Mike Mahoney: Welcome, everyone, to another Ogletree Deakins podcast. I’m Mike Mahoney, a shareholder in our Morristown, New Jersey and New York City offices. I’m the chair of our payroll tax and fringe benefits team. I’ve been tracking the employee retention credit legislation and guidance since its inception in March of 2020 and have assisted many clients in claiming the refunds. Joining me today is Viki Farrior. Viki is an of counsel based out of Ogletree’s Oklahoma City office and is a trial lawyer with over 10 years of litigation experience. Prior to joining Ogletree, Viki was a trial attorney with the Department of Justice Tax Division and a special trial attorney with the IRS Office of Chief Counsel. Viki has extensive experience with jury and bench trials and has been responsible for all aspects of civil litigation including case strategy, motions practice, conducting discovery, trial practice, and negotiating settlements. Thanks for joining us today. We’re going to be discussing options available to employers who have claimed employee retention tax credits but have not yet received their refunds. So, with that, Viki, can you just give me an overview of the state of IRS tax credit processing currently?

Viki Farrior: Sure. Hi, good morning, Mike. I’m so glad to be here. Thanks for having me. So, the state of the IRS ERTC process currently, as you know better than anyone, the IRS issued a moratorium last year in September, basically putting a stop to the audit and review of all the employee retention tax credit returns that were claiming the credit. And this moratorium or this pause carried through until about August this year, where the IRS semi-lifted the moratorium. I mean, they said they were going to start processing claims. They’ve now carried it over into this three-category set where they’re characterizing the refund claims as either low risk, unacceptable level of risk, or high risk, and most of the claims actually fall into this amorphous, medium risk, unacceptable level of risk category.

About 60 to 70% of all claims are in this limbo, just languishing. IRS has said they’re processing their low-risk claims. We don’t really know what constitutes a low-risk claim. They haven’t explicitly said as much, nor are they telling us what high-risk claims are other than to throw around fraud as the reason why they are delaying auditing these claims. So yeah, most claims are kind of stuck in this in-between purgatory state where they’ve submitted their claims, and they’re just waiting, waiting for IRS to review it, waiting for IRS to deny it, approve it, make a decision one way or another.

Mike Mahoney: I know that’s been a real challenge for a number of our clients because they don’t quite know where they fall in that spectrum. I suppose presumably if anyone knows that they committed fraud, then they know which category they’re in. But it’s been a real challenge, and without some system to identify where they fall on that spectrum, I think you used the word languishing. Many of our clients are just languishing and awaiting some determination at some unspecified time in the future.

Viki Farrior: You had mentioned that taxpayers don’t really know which category they’re in, and there’s no way to know. We’ve gotten questions about this, well, how do I know which category I fall into? And the short answer is, there’s no way to know. You’re most likely in this middle category, which it seems 60 or to 70% of claims fall into this middle category of what they’re calling an unacceptable level of risk. But again, there’s no way to know what that means.

Mike Mahoney: I mean, surely, we’ve got to find a way forward for our clients. What are some options for clients without an approved claim who are just uncertain as to where they stand with the IRS?

Viki Farrior: Yeah, so it seems like there’s really two very viable choices. The first is continue to wait. Wait for your claim to be audited, wait for the appeals process to initiate. I mean, you can go the administrative route, which is essentially staying with IRS, giving IRS more time to review your claim. That might be a year from now; it might be two years from now. It might be that you’re just waiting indefinitely. The other option is the refund suit option, which is available to anyone who has filed a claim for refund and six months or more have elapsed. This is statutory. This is section 6511 of the tax code that gives you the statute of limitations for the refund suit, and then 7422, which authorizes filing of a suit for refund, so long as you’ve met certain requirements.

Mike Mahoney: When someone brings a refund suit, what types of recovery are available?

Viki Farrior: Well, it’s not damages in your traditional sense. We’re talking about tax refund tax litigation, and so typically, you have your claim, the principal amount of the refund that you had claimed on your return, or the Form 843 if that was the form that you filed claiming a refund. So, let’s call it the principal amount that you claim that you overpaid in tax. Then, there’s potentially interest, which accrues and compounds daily and currently is at an 8% rate. And then potentially costs and fees. Attorney’s fees are notoriously difficult to win against the federal government. There is a standard, and that is that the government isn’t on the hook for attorney’s fees in these cases, where even where they lose, so long as they can show they were substantially justified in the position that they took.

So, that’s always been kind of a hurdle in tax litigation. But in cases such as this where the IRS has not even audited these claims and doesn’t seem to be making a whole lot of effort to push these cases and unclog those pipes, we believe that there’s a pretty good argument to a federal judge that how can you be substantially justified in a position that you haven’t even taken with respect to reviewing these claims.

Mike Mahoney: I know we have some clients who filed over 18 months ago and are still awaiting even just minimal contact from the IRS. So, it sounds like that might be a good instance where there really wasn’t a justification for that extensive of a delay.

Viki Farrior: Yeah. And if you read some of the articles that are floating around right now about the moratorium, about other efforts to kind of push the IRS to start reviewing these claims in earnest, there hasn’t really been a whole lot of success. I mean, you’ve seen law firms try and argue that, well, the moratorium is a violation of the Administrative Procedures Act. It’s arbitrary and capricious, and essentially asking federal judges to enjoin or force the government to lift the moratorium and continue processing these refund claims. That line has been unsuccessful.

I think I’ve counted two U.S. district courts that have refused to issue such an injunction or make such a declaration mandating essentially that the IRS lift its moratorium and continue to process claims. So, the other viable option is you can either wait until your claim is actually denied, either partially or in full, or if it’s been six months and the clients that we’ve worked with that have been waiting for 18 months, sometimes this is a very attractive option.

People are tired of waiting. Their money, they feel that it’s held in the government. This is money that was intended to help them during a pandemic, sort of give a boon to the struggling financial and economic situation that all of us were in not that long ago. And this cash infusion would make a huge difference in the lives and the daily goings and comings and goings and business decisions of our clients. So, it makes a lot of sense for some clients. For others, a completely reasonable and rational decision to decide to just wait and see what happens. But what we’ve started seeing is more refund suits getting filed. And as far as I know, I think we’re the only ones going to the Court of Federal Claims.

Mike Mahoney: Can you talk to me about what the refund suit process is, and to the extent we have some insight, maybe provide some guidance on timeline?

Viki Farrior: Yes. Yes. So, I think a little bit of a tax procedure kind of background is important to understand the refund suit process. So, with tax litigation, you’ve got two basic postures. The first is you either owe money to the government, you’ve underpaid your taxes, or you’ve overpaid your taxes, in which case you’re sort of in this refund posture. If you owe money to the government, your choices are, you’ve got several. You can go, as long as you’ve met certain statutory requirements as far as timing, you can go to the U.S. Tax Court, and the U.S. Tax Court is a venue that you don’t have to prepay your tax in order to get heard or get your case in front of a judge. It’s a very attractive option. A lot of tax litigation occurs at the tax court. You have specialists that are appointed to hear these disputes, and in general, it is a very attractive option for taxpayers to just not have to fully pay their tax in order to get their case heard.

With refund suits, it’s a little bit different. So, the tax court does not hear refund suits. Your options for filing a refund suit are either the U.S. District Court nearest you or the Court of Federal Claims, and the Court of Federal Claims sits in Washington D.C. It’s a court of limited jurisdiction in that it only hears disputes against the federal government. And so that said, it is not a stranger to tax litigation and has its own procedures when it comes to civil tax litigation. So, once you figure out where you want to file your suit, you need to make sure you’ve met all the basic requirements, statutory requirements to do so. Number one, it’s been six months since you’ve filed your claim, and that you actually made a formal claim for refund. Typically, the formal claim for refund is just the tax return that you filed, claiming that you’ve overpaid your taxes.

Now, sometimes taxpayers will file either an amended return or a Form 843, which is the administrative claim for refund. Any one of those filings will constitute the formal claim to satisfy the statutory prerequisite under 7422. Once you’ve decided which court you want to be in, whether it’s the U.S. District Court, whether it’s the Court of Federal Claims, you file your complaint and then under the rules, the government gets 60 days to answer. This can be extended obviously by agreement, and it’s usually unnecessary to do so. 60 days is usually more than sufficient, and oftentimes the government will answer prior to that.

Now, what ensues is just basic federal civil trial practice and procedure, which is you have your initial disclosures, you engage in the opening conference where you lay it all out with the other side, broach the issue of settlement, see what kind of negotiations you can engage in early on. And I mean, it looks very much like any other civil litigation case going to trial. Now, whether trial is necessary in these cases, that is a function of factual development, factual disputes, but it looks very much like any other civil case that you’ve filed in federal court.

Mike Mahoney: Viki, having filed several of these refund claims, can you provide some insight on the government’s approach in responding to these suits?

Viki Farrior: Yeah, so we have filed a few of these complaints for refund so far, and it is still a fairly new substantive area. The refund suit is not new. I mean, this has been available since time immemorial. However, this particular cause of action based off of the CARES Act and a very recently sanctioned congressional tax benefit, this ERTC, it’s really now that we’re starting to see this influx of refund suits getting filed. I’ve spoken with some of my colleagues, former colleagues at DOJ, they’ve said, “Yes, none of these cases have gone the full scope of the litigation.” None of them have seen the end of the rainbow to know, well, what can we say about the rate of settlement versus the rate of motions for summary judgment or trial? None have gone that route. They’re all still in their kind of infancy stage, these complaints.

But in the words of the government, IRS is being inundated with these claims. And what is likely to happen at this point, given that there is essentially a standoff between the agency and the taxpayers and the agency has essentially messaged to the taxpayer as well, “If you really think you are owed this refund, if you have a valid claim, why don’t you go and file suit in order to get it?” When that happens, whether, again, whether you file in Court of Federal Claims or District Court, the DOJ needs an agency authorization before they’re able to defend in the litigation. So, that takes some time, but what usually happens is they send what’s called a defense letter. Defense letter asks the IRS to obviously issue all the litigation holds necessary, compile documents related to that particular taxpayer and tax period, and to send those files to the DOJ in some timely fashion because, again, they have 60 days to answer.

And so, a lot needs to happen in that 60 days. The sense that I’ve gotten is that the IRS is asking DOJ in these suits that they have been sued for refund, these ERTC suits, to defend the case. And what that means is we want you to answer, we want you to issue discovery, but we are essentially washing our hands of this and we’re leaving it in your very capable hands, DOJ, to get to the right result. So yeah, it’s a process that could take anywhere from six to nine months, we’re estimating, and that is just based off of the average time that these suits tend to take to get developed. But especially in the Court of Federal Claims that doesn’t have a massive criminal docket the way the federal district courts do, and they only do hear this limited subset of cases that are against the federal government. We believe that the start, the time between when you file your suit and when you get to some kind of resolution should take about six to nine months.

Mike Mahoney: Thanks, Viki, for taking the time to talk about this innovative refund suit option today, and thanks everyone for listening.

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