In a legal action concerning the IRS’s handling of Employee Retention Credit (ERC) claims taking place in the U.S. District Court in Arizona, two opposing documents outline significantly different perspectives on the matter. The plaintiffs, Stenson Tamaddon, LLC, and ERC Today, LLC, argue for a preliminary injunction against the IRS, asserting violations of the Administrative Procedure Act (APA) and the Fifth Amendment Due Process Clause. The IRS, in its opposition, contests these claims, defending its procedures and challenging the plaintiffs’ standing and legal arguments.

Plaintiffs’ Arguments for Injunctive Relief

The plaintiffs’ central claim is that the IRS has implemented an arbitrary and capricious system for denying ERC claims, using automated "filters" to make decisions without individualized review. They contend that the IRS created a system to "disallow ERC in mass". The IRS is accused of using these filters despite acknowledging their limitations and lack of sufficient taxpayer information. The plaintiffs assert that this violates the APA, which requires that agency action be "reasonable and reasonably explained". They cite Fed. Commc’ns Comm’n. v. Prometheus Radio and Cayuga Nation v. United States to support their argument that the IRS must show a "rational connection between the facts found and the choice made". According to the plaintiffs, the IRS failed to collect necessary data to evaluate eligibility, such as whether claims were under the "government orders" or "gross receipt decline" tests. They argue that the IRS "did not require reporting of quarterly wages in comparison with prior tax years" and "did not ask employers to identify the government orders impacting each business".

The plaintiffs also argue that the IRS changed its procedures without notice, initially instructing taxpayers to file Form 941-X with minimal documentation, then denying claims based on a lack of information that the IRS had previously told them to withhold. They state, "IRS instructed employers to claim ERC through a Form 941 or 941-X (amended return), but then told taxpayers to withhold documentation bearing on eligibility". This, they argue, conflicts with the APA and constitutes a violation of due process.

Furthermore, the plaintiffs claim the IRS is improperly limiting taxpayers’ appellate rights by funneling appeals to revenue agents for examination before they can reach the Independent Office of Appeals, thus delaying the process and jeopardizing the two-year statute of limitations for administrative appeals. The plaintiffs emphasize that the IRS is "hijacking taxpayer administrative rights by diverting appeals to revenue agents for examination rather than into the IRS Office of Independent Appeal". They argue that the IRS is "betting that most businesses will instead forgo those expenses and walk away from legitimate ERC claims".

IRS’s Opposition to the Preliminary Injunction

The IRS, in its opposition, argues that the plaintiffs lack standing to bring the case and that their claims fail on the merits. The IRS states that the plaintiffs’ "injuries are traceable to their business model, not the IRS’s claim review procedures". The IRS argues that the plaintiffs are not the direct objects of the challenged government action, and their injuries are not caused by the IRS but rather by their chosen contingency-based business model. The IRS claims that it does not have an obligation to pay the plaintiffs and that any secondary injury suffered by the claimant’s creditor, deal partner, or local taxing authority is not fairly traceable to the IRS. The IRS emphasizes that "the risk of nonpayment is inherent in the fee structure StenTam created". The IRS also argues that the relief the plaintiffs seek is not substantially likely to redress their injuries.

The IRS defends its use of "risking," a process to sort claims by risk, as reasonable and necessary for efficient resource management. The agency asserts that it uses this process to determine which claims are likely eligible and should be allowed, which are highly unlikely to be eligible and should be disallowed, and which are potentially eligible and should be subject to an audit. They argue, "A risking-based disallowance simply signals the agency’s belief, which is at the heart of its discretion, that the claim is sufficiently unlikely to be allowed, such that the IRS’s Exam resources can be better spent elsewhere". The IRS also maintains that it is committed to ensuring that all proper ERC claims are allowed.

The IRS further contends that its actions are not arbitrary or capricious. It states that it "has developed criteria to determine how to process ERC claims, including which to select for audit". They argue that no statute requires the IRS to examine a refund claim before denying it or to provide an immediate administrative appeal. The IRS states, "Whether and how to examine and process returns, including those making ERC claims, is committed to agency discretion and thus unreviewable". They also claim that the plaintiffs cannot challenge the claim disallowances under the APA because there is an adequate alternative remedy in the form of a refund suit under 26 U.S.C. § 7422.

Regarding the appeals process, the IRS argues that taxpayers still have the option to appeal and that the process of sending information to Exam first is actually taxpayer-friendly. The IRS contends, "If a taxpayer requests Appeals consideration, the taxpayer should send the request to the IRS. The IRS will consider the taxpayer’s explanation and documentation before sending the request to Appeals". They claim this allows the IRS to quickly allow the claim if the taxpayer’s documentation clearly supports it, and because "Appeals is not the first finder of fact, any new information would need to be sent back to IRS examination for review anyway".

Contrasting Views

The plaintiffs depict a system where the IRS is using flawed automated systems to deny claims without proper review, violating the APA and due process rights. They portray the IRS as acting with "deliberate indifference toward a plaintiff’s constitutional rights". In contrast, the IRS presents itself as managing a high volume of claims with limited resources, using risk assessment to efficiently process claims and protect the public fisc. The IRS emphasizes that it is "committed to ensuring that all proper ERC claims are allowed" and that the current system "appropriately balances efficiency against accuracy".

The plaintiffs argue that the IRS is preventing taxpayers from receiving their due refunds and is forcing them into costly litigation. They state that "the IRS is betting that most businesses will instead forgo those expenses and walk away from legitimate ERC claims". The IRS, however, points out that taxpayers have three options for challenging a disallowance: providing additional documentation, appealing to the IRS Independent Office of Appeals, or filing a refund suit in district court.

The differing perspectives highlight a fundamental disagreement on the fairness and legality of the IRS’s ERC claim processing system. The plaintiffs argue for individualized review and adherence to traditional procedures, while the IRS emphasizes the need for efficient resource management and the protection of public funds, stating, "The IRS employed a reasonable process, and if the agency erred as to any particular claim, that claimant has multiple avenues for administrative and judicial review".

Legal Citations

The plaintiffs cite cases such as Scholl v. Mnuchin, 494 F. Supp. 3d 661 (N.D. Cal. 2020), Farm Sanctuary v. United States Dep’t of Agric., 664 F. Supp. 3d 334, 364 (W.D.N.Y. 2023), and Sylvia Landfield Tr. v. City of Los Angeles, 729 F.3d 1189 (9th Cir. 2013) to bolster their claims of arbitrary agency action and due process violations. They also cite Winter v. Nat. Res. Def. Council, Inc., 555 U.S. 7 (2008) in discussing the legal standards for obtaining a preliminary injunction.

The IRS counters with Heckler v. Chaney, 470 U.S. 821 (1985), to argue that the actions Plaintiffs seek to challenge are committed to agency discretion, and United States v. Nordic Village, Inc., 503 U.S. 30 (1992) to argue that any waiver of sovereign immunity must be unequivocally expressed. It cites TransUnion LLC v. Ramirez, 594 U.S. 413 (2021) regarding the burden of proof to demonstrate standing. The IRS also cites Garcia v. Google, Inc., 786 F.3d 733 (9th Cir. 2015), to argue for heightened scrutiny on the mandatory injunction the plaintiffs are seeking.

Conclusion

The legal documents reveal starkly opposing views on the IRS’s ERC claim processing. The plaintiffs allege systemic violations of law and due process, while the IRS defends its actions as reasonable and necessary under the circumstances.

Prepared with assistance from NotebookLM.

The IRS response can be read here.