Proposed Regs on Erroneous ERC Refunds Won’t Fly, Firm Warns

August 15, 2024

CC:PA:01:PR (REG-109032-23)
Room 5203
Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, DC 20044

To Our Colleagues at the Treasury Department and Internal Revenue Service:

We write in response to the proposed regulations published July 2, 2024 in the Federal Register on the subject of the recapture of interest on, among other items, excess Employee Retention Credits (REG-109032-23). We observe that these proposed regulations would be companions to final regulations published a year ago that treat erroneous refunds of payroll taxes arising from Employee Retention Credit ("ERC") claims as underpayments of tax (T.D. 9978). Regrettably, no public comments were submitted on those points when the previous regulations were proposed and issued as temporary regulations. Therefore, we write to urge you both to abandon the current proposed regulations as they relate to the ERC, and to reconsider the appropriateness of the final regulations treating excessive ERC refunds as underpayments of tax, particularly in light of the Supreme Court's recent decision in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024).

In Loper Bright, the Supreme Court clarified the role of executive agencies in interpreting legislative language and reminded us that courts would look critically upon agency actions that exceed Congressionally-bestowed authority. The Court wrote that courts' high degree of deference to agencies should be "cabined to factbound determinations" and that reviewing courts must "'decide all relevant questions of law' and 'interpret . . . statutory provisions.'" Loper Bright, 144 S. Ct. at 2249, 2265. For the reasons described herein, we believe the proposed regulations, as well as the final regulations from last year, are unlawful. We urge you to reconsider this regulatory scheme and amend your position to recognize the important protections that Congress intended for the small businesses that kept Americans employed during the darkest days of a global pandemic through participation in the ERC program.

This is an important issue for the country. The IRS has repeatedly stated its view that many ERC claimants were not eligible and has promoted its efforts to recover billions of dollars in allegedly erroneously paid ERC claims. The IRS should be extremely wary of using an unlawful procedure to recover those funds, as it would risk the Government's ability to retain them.

We address the regulatory scheme in chronological order, first by outlining our concerns with the final regulations that establish this inappropriate regulatory scheme, and next by pointing out how the proposed regulations compound the issues created by the final regulations, exacerbating the impact on taxpayers even further. We note, at the outset, that we represent a number of small businesses that have filed ERC claims, as well as advisors who assisted small businesses in evaluating and/or filing their claims. However, no client has paid for the time we have spent preparing or submitting this comment, and no client has provided any input.

Final Regulations (T.D. 9978)

As the IRS recognized when it first proposed the final regulations, "non-rebate refunds" of refundable credits that are erroneously paid are generally recovered or recaptured through voluntary payment or litigation:

Section 6201, in general, authorizes the Secretary to determine and assess tax liabilities including interest, additional amounts, additions to the tax, and assessable penalties. However, the general authority to assess tax liabilities under section 6201(a) does not allow the assessment of any non-rebate portion of an erroneous refund of a refundable credit. Instead, non-rebate refunds are generally recovered or recaptured through voluntary payment or litigation. The government by appropriate action can bring civil litigation to recover funds which its agents have wrongfully, erroneously, or illegally paid, and no statute is necessary to authorize the government to sue in such a case, since the right to sue is independent of statute. United States v. Wurts, 303 U.S. 414, 415 (1938), citing United States v. The Bank of the Metropolis, 40 U.S. 377 (1841). However, the statutory language of the Families First Act and the CARES Act provides for the administrative recapture of these non-rebate refunds by authorizing the promulgation of regulations or other guidance to do so.

T.D. 9904 (footnote omitted).

We agree with the IRS that Section 6201 does not authorize the IRS to recover erroneously paid non-rebate refundable credits via assessment. Our concern is that the IRS gave itself this authority via administrative fiat by issuing the final regulations. As the IRS also explained in the preamble to the temporary regulations:

Any credits claimed that exceed the amount to which the employer is entitled and that are actually credited or paid by the IRS are considered to be erroneous refunds of the credits. These temporary regulations provide that erroneous refunds of these credits are treated as underpayments of the taxes imposed under sections 3111(a) or 3221(a) of the Code and authorize the IRS to assess any portion of the credits erroneously credited, paid, or refunded in excess of the amount allowed as if those amounts were tax liabilities under sections 3111(a) and 3221(a) subject to assessment and administrative collection procedures. This allows the IRS to efficiently recover the amounts, while also preserving administrative protections afforded to taxpayers with respect to contesting their tax liabilities under the Code and avoiding unnecessary costs and burdens associated with litigation. These assessment and administrative collection procedures will apply in the normal course in processing employment tax returns that report advances in excess of claimed credits and in examining returns for excess claimed credits.

Specifically, these temporary regulations provide that any amount of the credits for qualified leave wages under sections 7001 and 7003 of the Families First Act, plus any amount of credits for qualified health plan expenses under sections 7001 and 7003, and including any increases in these credits under section 7005, and any amount of the employee retention credit for qualified wages under section 2301 of the CARES Act that are erroneously refunded or credited to an employer shall be treated as underpayments of the taxes imposed by section 3111(a) or section 3221(a), as applicable, by the employer and may be administratively assessed and collected in the same manner as the taxes. These temporary regulations provide that the determination of any amount of credits erroneously refunded must take into account any credit amounts advanced to an employer under the process established by the IRS in accordance with sections 7001(b)(4)(A)(ii) and 7003(b)(3)(B) of the Families First Act and section 2301(l)(1) of the CARES Act.

We offer two principal objections to the final regulations:

The regulations claim to derive authority principally from two sources: section 2301(l) of the CARES Act, as amended, and the corresponding Section 3134(m)(3) of the Code, providing "that the Secretary shall issue such forms, instructions, regulations, and other guidance as are necessary to prevent the avoidance of the purposes of the limitations under [the ERC enabling legislation]." (Emphasis added).

The preamble to the regulations states that the recapture provisions "allow[ ] the IRS to prevent the avoidance of the purposes of the limitations under the credit provisions and to recover the erroneous refund amounts efficiently while also preserving administrative protections afforded to taxpayers with respect to contesting their tax liabilities under the Code and avoiding unnecessary costs and burdens associated with litigation." As previewed above, we believe the regulations accomplish none of those goals.

“The limitations under" section 2301 of the CARES Act (as amended) and under Section 3134 relate to discrete topics: (1) a per-employee qualified wage limit, (2) a per-quarter limit for recovery startup businesses, and (3) a limit on the total allowable credit equal to "applicable employment taxes." The CARES Act and Section 3134 give an example of a structure that could avoid the purposes of these limitations: "the leaseback of employees." While it is clear that the Treasury Department is permitted to prescribe regulations to prevent certain avoidance efforts — for example, to prevent an employer from structuring its operations to exceed the per-employee qualified wage limit — Congress has provided no statutory authority for the Department to transform a credit overpayment into an underpayment of tax.

No other aspect of the legislation provides any such delegation of authority. Indeed, the legislative scheme suggests the opposite: Section 3134(j)(3)(B) of the Code and the corresponding section of the CARES Act create, with respect to advance payments to small employers, a limited circumstance in which an excessive ERC payment may be assessed as a tax:

If the advance payments to a taxpayer under paragraph (2) for a calendar quarter exceed the credit allowed by this section (determined without regard to subparagraph (A)), the tax imposed under section 3111(b) or so much of the tax imposed under section 3221(a) as is attributable to the rate in effect under section 3111(b) (whichever is applicable) for the calendar quarter shall be increased by the amount of such excess.

This narrowly tailored legislative carve-out reveals that Congress never intended for the IRS to wield general assessment authority with respect to ERC overpayments.

Furthermore, the final regulations erode procedural protections the Code affords to taxpayers who receive excessive ERC refunds. The Treasury Department correctly recognizes that, if an excessive refund were treated (properly) as an overpayment, the IRS could not make an assessment against the taxpayer on account of the excessive refund. As the preamble explains, the final regulations "provide that erroneous refunds of COVID-19 credits are treated as underpayments . . . and are, therefore, subject to assessment and administrative collection procedures." (Emphasis added.) In other words, Treasury acknowledges that, absent these regulations, the only way for the Government to recover an excessive refund would be to institute a civil action in Federal court. There, the Department of Justice would bear the burden of proving that the refund was erroneous.

On the other hand, if an excessive ERC refund were treated as an underpayment, a taxpayer would have greatly diminished procedural protections. Because payroll taxes are not eligible for deficiency procedures, the collection powers of the IRS would be brought to bear against the taxpayer summarily, even though no actual underpayment of tax ever occurred. The taxpayer would not only lose access to a court in which the Government bore the burden of proof; the taxpayer would have to endure significantly more procedural hurdles to obtain any judicial review of the IRS determination that the taxpayer received an excessive refund, either paying out of what may be critically important operating funds and filing suit (where the taxpayer would bear the burden of proving entitlement to a refund absent any burden-shifting under, e.g., I.R.C. §7491) or attempting to use collection due process procedures (where the taxpayer would, again, potentially bear the burden).¹ And, even then, the Tax Court's "prior opportunity" precedent may prevent taxpayers from raising the merits of their claims in Tax Court.

Moreover, an underpayment regime is substantively worse for taxpayers. The Internal Revenue Service has repeatedly warned taxpayers that it is prepared to assert underpayment penalties for excessive ERC refunds. Those penalties, found in Sections 6662 and 6663 of the Code, apply where there is an "underpayment of tax required to be shown on a return." An "underpayment," defined in Section 6664(a) for purposes of the penalty regime, is:

[T]he amount by which any tax imposed by this title exceeds the excess of —

(1) the sum of —

(A) the amount shown as the tax by the taxpayer on his return, plus

(B) amounts not so shown previously assessed (or collected without assessment), over

(2) the amount of rebates made.

For purposes of paragraph (2), the term "rebate" means so much of an abatement, credit, refund, or other repayment, as was made on the ground that the tax imposed was less than the excess of the amount specified in paragraph (1) over the rebates previously made. A rule similar to the rule of section 6211(b)(4) shall apply for purposes of this subsection.

Here, "his [the taxpayer's] return" refers to the taxpayer's original return. See, e.g., Goldring v. Commissioner, 20 T.C. 79, 82 (1953) ("the phrase the return has a definite article and a singular subject; therefore, it can only mean one return"). Thus, by definition, underpayment penalties do not apply to refund claims. Consequently, absent these final regulations, taxpayers receiving excessive ERC refunds would not be subject to underpayment penalties. Indeed, because the Section 6676 "erroneous claim for refund or credit" penalty only applies to income taxes, without the final regulations, it is doubtful that taxpayers receiving excessive ERC refunds would be subject to any penalties at all. On account of these regulations, taxpayers will be inappropriately subjected to assessment and collection procedures not only on excessive refunds, but also on statutorily inapplicable penalties.

With such drastic consequences for taxpayers — where losses of both procedural and substantive protections are at stake in the transformation of an excessive refund into an underpayment — we would submit that the Treasury Department should not act without a clear delegation of authority from Congress. No such delegation exists; on the contrary, the only delegation of authority for the IRS to assess was limited to advance payments to small employers.

Proposed Regulations (REG-109032-23)

The regulations proposed on July 2nd only augment these concerns. The Explanation of Provisions provides as follows:

These proposed regulations would provide that any overpayment interest paid under section 6611 to an employer for an erroneous refund of the COVID-19 credits will be treated as an underpayment of the taxes imposed under section 3111(a) or (b), as applicable, and so much of the taxes imposed under section 3221(a) as are attributable to the rate in effect under section 3111(a) or (b), as applicable, and may be assessed and collected by the Secretary in the same manner as the taxes.

Just as Congress provided no statutory authority for the Treasury Department to transform an excessive ERC refund into a tax underpayment, Congress provided no statutory authority for the Treasury Department to add related overpayment interest to that imagined underpayment. And, just as Congress provided a clear procedure for the Government to recover excessive ERC refunds — that is, filing suit pursuant to Section 7405 — the IRS is limited to the same procedure for recovering erroneously paid overpayment interest. The proposed regulations represent an extension of a regulatory scheme that already stands contrary to the ERC legislation, and they further erode the protections Congress has afforded taxpayers who received ERC refunds.

Thank you for your consideration of our comments. We believe a public hearing on this subject would be beneficial and request the privilege of sending a representative to appear and testify. We look forward to the opportunity to discuss these matters further at that time.

Very truly,

Tom Cullinan

Larry Campagna

John W. Hackney

Philip Karter

Charles P. Rettig

Kevin F. Sweeney

Leo Unzeitig

Jaime Vasquez

Samuel T. Kuzniewski

Jerrika Anderson

Asher Fried

Kristen S. Lowther

Victor J. Viser

Chamberlain, Hrdlicka, White, Williams & Aughtry, P.C.
Atlanta, GA