Federal Court Upholds IRS's ERC Guidance, Allows Taxpayer Refund Lawsuit to Proceed

A federal judge in Arizona delivered a split decision this month in a closely watched case concerning the Employee Retention Credit (ERC), allowing a consulting firm's lawsuit to recover a specific refund to move forward while simultaneously dismissing its broader challenge to the validity of the IRS's foundational guidance for the program.

The June 12 ruling from the U.S. District Court for the District of Arizona in Stenson Tamaddon LLC v. IRS provides a partial victory for the taxpayer, permitting it to argue the merits of its 2021 ERC claim in court. However, the decision is a more significant win for the Internal Revenue Service, as it preserves the legal underpinnings of the agency's entire ERC enforcement framework, which has come under intense scrutiny.

This mixed outcome underscores the increasingly complex and high-stakes environment for businesses still navigating the pandemic-era tax credit, many of whom have claims that are delayed, under audit, or have been denied.

The core of the dismissed portion of the lawsuit centered on the Administrative Procedure Act (APA). Stenson Tamaddon argued that IRS Notice 2021-20, which contains the agency's primary guidance on ERC eligibility, constituted a "legislative rule." If the court had agreed, the notice would have been invalidated because the IRS did not follow the APA's formal public notice-and-comment rulemaking process before issuing it. Such a finding could have thrown the entire ERC program into chaos, potentially nullifying the basis for thousands of IRS audits and claim denials.

However, the court sided with the IRS, classifying Notice 2021-20 as an "interpretive rule." This distinction is critical. Interpretive rules, which merely clarify an agency's interpretation of existing statutes passed by Congress, are not subject to the same stringent APA requirements. The ruling effectively affirms that the IRS had the authority to issue its ERC guidance as it did, solidifying the legal ground on which it has been processing, auditing, and denying claims.

While the challenge to the rules failed, the court determined that Stenson Tamaddon's suit to recover its specific refund could proceed. This means the company will now have its day in court to prove it was eligible for the credit under the very rules it unsuccessfully tried to invalidate. This path—filing a refund suit after a claim is denied—remains a primary recourse for businesses that disagree with an IRS determination.

In our experience, this judicial outcome reinforces a hard reality for businesses: challenging the IRS on procedural grounds is an uphill battle. The agency's victory on the validity of its guidance means the existing rules are the battlefield. For companies facing an audit or a disallowance notice, the focus must be on substantiating the original claim with meticulous documentation. This isn't just about having payroll records; it's about proving eligibility through detailed analysis of government orders, revenue declines, and operational impacts. Navigating this complex audit and appeals process is a specialized task.

The ruling comes amid a period of intense IRS action on the ERC program. Citing widespread fraudulent claims and aggressive marketing from so-called "ERC mills," the IRS instituted a moratorium on processing new claims filed after September 2023 and has significantly ramped up enforcement. The agency is using a variety of tools to challenge questionable claims, leading to long delays and uncertainty for many small and mid-sized businesses.

Companies with pending or denied claims may receive several types of correspondence from the IRS. These include Letter 105-C, which is a formal notice of full disallowance, and Letter 106-C, which indicates a partial disallowance. Other businesses may receive Letter 6612, which initiates a formal audit and is typically accompanied by a Form 4564 Information Document Request (IDR). According to the IRS, taxpayers who receive a disallowance notice generally have a two-year period to file a lawsuit to contest the decision.

For many business owners, the process can be frustrating, as IDRs are often generic and not tailored to a specific company's situation. Furthermore, notices like Letter 4384C can halt processing for procedural reasons, such as the IRS determining that the person who signed the claim was not an authorized signatory for the company.

Successfully defending a claim under these conditions requires a robust and well-organized response. This is why professional guidance is so critical when facing IRS scrutiny over these complex credits. For businesses struggling with disallowed or delayed claims, the path forward involves strategic tax preparation and compliance, which is a core service C&S Finance Group LLC provides at csfinancegroup.com. We help clients assemble the necessary proof and navigate communications with the IRS to resolve these matters effectively.

With the court in Arizona affirming the IRS's core guidance, the agency is expected to continue its aggressive enforcement campaign with renewed confidence. The focus for businesses and their advisors must remain on building an ironclad, evidence-based case for eligibility from the outset.

Looking ahead, the Stenson Tamaddon refund suit will now proceed on its specific merits. The outcome of that portion of the case will be watched closely by other businesses considering litigation. Meanwhile, the broader legal landscape for the ERC remains settled for now, with the IRS's foundational rules intact as it works through a massive backlog of complex and often contentious claims.