The Disallowance Letter and Why It Is Not the Final Word
Over the past several years, the Employee Retention Credit has moved from aggressive marketing to aggressive enforcement. Many businesses that filed claims in good faith—and many that were pushed into claims by promoters—are now receiving disallowance letters from the IRS. If you have received one, the natural reaction is either resignation or panic. Neither serves you. A disallowance is an administrative determination that can be challenged, but only if you act within the applicable deadlines and through the correct procedure.
As counsel handling federal tax controversies, my first task with any disallowed ERC claim is to identify exactly what the IRS sent, what it decided, and what clock is now running.
Read the Letter Carefully
The IRS communicates ERC disallowances through formal correspondence, commonly a claim disallowance letter. The letter should identify the periods at issue, the amount disallowed, the stated basis for the disallowance, and your appeal rights. The stated basis matters enormously. Some disallowances rest on the IRS's conclusion that the business did not experience a qualifying government order or the requisite decline in gross receipts. Others rest on computational or eligibility questions. Your response strategy depends entirely on the reason given.
Equally critical is the deadline. A formal claim disallowance generally starts a limited period within which you must either pursue administrative appeal or file suit to preserve your rights. Missing that window can extinguish your ability to recover the credit, regardless of the merits.
Option One: Administrative Appeal
In many cases, the first and most efficient path is to request consideration by the IRS Independent Office of Appeals. Appeals is separate from the examination function and evaluates the hazards of litigation, which often creates room for resolution where the examining unit took a rigid position. To use this path effectively, you must present a well-organized factual and legal case: the specific government orders that suspended or partially suspended operations, the nature and degree of the suspension, or the gross-receipts data supporting eligibility.
An appeal is not a place for generalities. It rewards a precise, evidence-backed demonstration that the business met the statutory eligibility standard for each period claimed.
Option Two: Refund Litigation
Where administrative avenues are unavailable or unsuccessful, a business may pursue its claim through refund litigation in the appropriate federal court. Refund suits have their own procedural prerequisites and deadlines, generally tied to the disallowance and to the payment posture of the claim. Because these deadlines interact—and because filing suit prematurely or too late can be fatal—the decision to litigate should be made with a clear map of every applicable limitations period.
Litigation is more resource-intensive than appeals, but for substantial claims with strong facts, it may be the appropriate forum, particularly where the IRS has adopted a legal position the business believes is incorrect.
Building the Eligibility Record
Whether you appeal or litigate, the outcome turns on the same core question: was the business actually eligible for the credit in each period claimed? Rebuilding and organizing the eligibility record is the heart of the work:
- For the government-order pathway, identify the specific orders in effect, their dates, and how they more than nominally suspended the business's operations.
- For the gross-receipts pathway, assemble the comparative revenue data by quarter with supporting records.
- Reconcile the claimed credit amounts with wages and any interaction with other relief programs.
Many disallowances can be traced to claims that were prepared by promoters without a genuine eligibility analysis. Where that occurred, the current task is to determine—honestly—whether eligibility in fact existed and can be proven.
When the Honest Answer Is That the Claim Was Weak
Not every disallowed claim should be contested. Part of responsible counsel is advising a client when the eligibility case is thin and the better course is to accept the disallowance rather than incur cost pursuing a claim unlikely to succeed. For businesses that filed questionable claims, there have also been IRS programs allowing withdrawal or repayment on favorable terms; whether such options remain available depends on timing and the posture of the claim.
The Overriding Priority: Protect the Deadline
The single most important action after receiving a disallowance is to calendar and protect every applicable deadline while the substantive analysis proceeds. I have seen strong claims lost not on the merits but because a limitations period expired during deliberation. Preserve your rights first; decide strategy second.
An ERC disallowance is a serious but navigable event. With a careful reading of the letter, a disciplined rebuild of the eligibility record, and strict attention to deadlines, businesses with legitimate claims retain meaningful avenues to recover what they are owed.
This article is provided for general informational purposes and does not constitute legal advice or create an attorney-client relationship.