What To Do If The IRS Disallows An ERC Claim

On Behalf of the Law Offices of Sammy Kim

Quick Summary

The Employee Retention Credit was a significant federal program designed to help businesses that kept employees during the COVID-19 pandemic. Many businesses that claimed the credit did so correctly. Some overclaimed. And some were steered into claims by promoters who did not apply the rules carefully. The IRS is now aggressively auditing and disallowing ERC claims. Understanding why claims are disallowed and what to do when the IRS sends a notice is critical.

Why The IRS Is Disallowing ERC Claims

The IRS has identified several categories of ERC claims that do not meet the program requirements. These include businesses that do not meet the revenue reduction or government order tests, businesses that claimed credits for wages paid to owners or relatives in excess of what the rules allow, and businesses that claimed for periods when they did not have the required nexus to the pandemic.

The IRS is also examining whether the ERC was duplicated with PPP loan forgiveness. The program rules prohibited claiming ERC on wages that were used to support PPP forgiveness. Businesses that received both programs and did not carefully separate the wage allocations may face disallowance on the overlap.

The IRS has signaled that ERC enforcement will continue for several years given the volume of claims filed and the resources devoted to the audit program. Businesses that received the credit should ensure their records support the qualifying criteria even if they have not yet received a notice.

What A Disallowance Notice Means

When the IRS disallows an ERC claim, it sends a notice demanding repayment of the credit plus interest and potentially penalties. The demand for repayment is in addition to any income tax consequences, businesses that deducted wages claimed under ERC must also adjust those deductions, which may require amended returns.

The IRS Voluntary Disclosure Program offered a limited opportunity for businesses to repay a portion of improperly claimed credits with reduced penalties. That program has closed. For businesses that did not use the VDP, the path is now through audit response or the standard appeal process.

A disallowance notice is not a final determination. The taxpayer has the right to respond, to provide documentation supporting the claim, and to appeal to the IRS Office of Appeals if the examining agent’s decision is unfavorable. The response to the notice sets the stage for what happens next.

Reviewing The Claim For Defensibility

Not every ERC disallowance is correct. The IRS has applied the rules inconsistently in some cases, and there are legitimate disagreements about how certain provisions apply, particularly around the government order test and how partial suspension of business operations is evaluated.

Before agreeing to repay, a business should have a tax attorney review the original claim documentation, the qualifying criteria that applied during the claim period, and the specific grounds for disallowance. If the original claim was supported by the facts and the rules, the disallowance should be challenged.

The documentation that supports an ERC claim includes payroll records, evidence of the government orders that affected the business, quarterly revenue figures, and any analysis performed at the time the credit was claimed. Businesses that worked with a promoter who did not provide documentation have a harder path, but the underlying facts may still support the claim.

The ERC Appeal Process

If the IRS disallows an ERC claim and the business disagrees, there are appeal rights. The process begins with a formal written protest to the IRS Appeals office that identifies the specific items in dispute and the legal and factual basis for disagreement.

The Appeals officer reviews the matter independently of the examining agent. If Appeals does not resolve the matter favorably, the business may have the option to petition the Tax Court. These proceedings require the documentation of the original qualifying circumstances and a legal argument for why the claim was valid.

The appeal window runs from the date of the notice. A business that receives a disallowance notice and does not respond within the applicable period loses the right to contest the disallowance at the Appeals level. Engaging an attorney promptly after receiving the notice preserves those rights.

Protecting Records While Enforcement Continues

Businesses that received the ERC and have not yet received a disallowance notice should treat audit preparation as an ongoing priority. The IRS statute of limitations for ERC claims is five years, which means a business that claimed the credit in 2020 or 2021 may receive an audit notice well into the mid-2020s.

Records that support the claim include payroll records for each quarter claimed, documentation of government orders that affected the business, quarterly gross receipts records, and any professional analysis that was done at the time of the claim. Keeping these records organized and accessible reduces the response burden when an audit notice arrives.

The Broader IRS Enforcement Context For ERC Recipients

ERC enforcement is taking place alongside the IRS’s broader focus on high-dollar examination cases. Businesses that received large ERC credits are statistically more likely to be audited than those that did not. The audit may focus solely on the ERC or may expand into other areas of the return once an examiner is assigned.

Businesses that overclaimed the ERC and are now under audit face the same fundamental question as any audit situation: is the liability correctly calculated, and are the available resolution tools being used effectively? An IRS appeal is available if the examiner’s proposed adjustment is incorrect. An Offer in Compromise may be available if the correct liability is established and the business cannot pay it.

The IRS has been clear that it will pursue ERC cases aggressively for years. That means businesses that took the credit, even legitimately, should treat their documentation as an active compliance matter rather than closed history. Government orders, payroll records, and the analysis supporting the claim should be organized and accessible. Reconstructing documentation after an audit notice arrives is harder than maintaining it in the first place.

Businesses that have multiple open IRS issues, an ERC audit alongside payroll tax compliance questions, for example, benefit from having a single attorney coordinate the strategy across all of them. Settlements or agreements on one issue can affect the IRS’s posture on others, and a coordinated approach consistently produces better total outcomes than handling each issue in isolation.

Working With A Tax Attorney On ERC Issues

The Law Offices of Sammy Kim works with businesses that received IRS ERC disallowances and need to evaluate their options. Call now at (703) 202-1005 before responding to the IRS , the response you file sets the stage for everything that follows.