Taxpayers Filing Court Challenges to Attempt to Obtain Employee Retention Tax Credits

The plaintiffs in both Hammill Manufacturing Co. v. United States and R.L. Morrissey & Associates, Inc. and American Ring Manufacturing, Inc. v. United States are making several claims regarding why their claims for refund under the Employee Retention Credit (ERC) should be granted. These claims can be broadly categorized into arguments for direct refund and challenges against IRS Notice 2021-20.

Claim for Refund of Payroll Taxes (First Cause of Action)

Both Hammill Manufacturing Co. (“Plaintiff”) and R.L. Morrissey & Associates, Inc. and American Ring Manufacturing, Inc. (“Plaintiffs”) are suing the United States for a refund of amounts paid to the Internal Revenue Service (“IRS”) plus interest pursuant to 26 U.S.C. §7422(a).

• Eligibility for ERC:
  • Hammill Manufacturing Co. states it qualified for the ERC under the Government Order Test for Q2 2020, Q3 2020, Q4 2020, Q1 2021, and Q2 2021 because it was compelled to suspend and/or modify a more than nominal portion of its business due to compliance with State, Local, or Federal government-issued orders limiting commerce, travel, or group meetings. This included decreased machining hours due to on-shift temperature checks, workplace sanitization mandates, and increased absences due to compelled quarantines, resulting in a ten percent (10%) or more decrease in machining hours.
  • R.L. Morrissey & Associates, Inc. and American Ring Manufacturing, Inc. state they qualified for the ERC under the Government Order Test for Q1 2021 and Q2 2021. They argue that cancelled trade shows and modifications to sales practices due to social distancing and capacity restrictions impacted their sales, while manufacturing operations experienced reduced efficiency and output due to spacing restrictions and employee absences. They also note that as a parent-subsidiary, a full or partial suspension of one company can be attributed to the other under 26 U.S.C. § 3134(d) and 26 U.S.C. § 52(a).
• Filing of Refund Claims: Both plaintiffs filed Forms 941-X with the IRS claiming specific amounts for the identified quarters.
• Failure to Pay Refund: The IRS has failed to pay out any of the claimed refunds.
• Statutory Requirements for Refund Suit: The plaintiffs assert they have met the requirements to file a refund suit under 26 U.S.C. § 7422 and 6532, as it has been at least six (6) months since the claims were filed, and the IRS has not disallowed them.
• Entitlement to Refund and Interest: The plaintiffs claim they are entitled to the specified refund amounts plus interest according to law.
• Attorney’s Fees: They also seek reasonable attorney’s fees and legal costs pursuant to 28 U.S.C. § 2412.

Challenges to IRS Notice 2021-20 (Second, Third, and Fourth Causes of Action)

Both plaintiffs are also suing the IRS to set aside IRS Notice 2021-20 and enjoin the IRS from enforcing it, arguing that it is invalid. Their arguments are based on violations of the Administrative Procedure Act (APA) and assertions that the Notice is contrary to law and arbitrary and capricious.

• Violation of the APA’s Notice-and-Comment Rulemaking Requirement (Second Cause of Action)
  • The plaintiffs argue that Notice 2021-20 is a substantive rule under 5 U.S.C. § 553(b)(3)(A).
  • They contend that the IRS failed to follow the notice-and-comment procedures required by the APA under 5 U.S.C. § 553 by not issuing a notice of proposed rulemaking, providing a statement of basis and purpose, or affording the public an opportunity to comment.
  • They assert that no good cause existed to eliminate the need for notice-and-comment rulemaking.
  • As a result, Notice 2021-20 subjected them to unreasonable and unexplained standards for ERC eligibility and credit calculations.
  • They request the court to set aside Notice 2021-20 as an invalid exercise of IRS authority under 5 U.S.C. § 706(2)(D) and to impose a nationwide injunction preventing its enforcement under 5 U.S.C. § 706(2).
  • They clarify that this cause of action does not seek to enjoin the collection of any tax or any refund for clients, but solely challenges the IRS’s failure to meet APA requirements under 5 U.S.C. § 553.
• Arbitrary and Capricious Agency Action (Third Cause of Action)
  • The plaintiffs claim that Notice 2021-20 is arbitrary and capricious under 5 U.S.C. § 706(2)(A) because it exhibits internally inconsistent reasoning and is not reasonably explained.
  • Specifically, they argue that the Notice:
    • Eliminates the Government Orders Test in favor of a modified Gross Receipts Test by imposing the “Ten Percent Test,” requiring a ten percent reduction in gross receipts or hours worked with no reasonable explanation for the chosen metrics or threshold. This allegedly contradicts the mutually exclusive nature of the Gross Receipts Test and the Government Order Test established by Congress.
    • Imposes a narrow and contradictory definition of “non-service” wages for “large” employers, limiting it to furloughed wages and excluding vacation, sick time, and other forms of personal leave, despite the CARES Act already providing a definition.
    • Narrows ERC eligibility by disqualifying employers whose operations were interrupted by government orders that didn’t directly target their business but nonetheless proximately caused an interruption, contrary to the CARES Act’s use of the broad term “due to” in 26 U.S.C. § 3134(c)(2)(A)(ii)(I). They cite Paroline v. United States, 572 U.S. 434, 445 (2014), arguing that "due to" includes causal connections unless the link is too attenuated.
    • Denies the ERC to businesses that “voluntarily” suspended operations due to COVID orders that decreased demand, even if continuing operations was commercially impractical.
  • They request the court to enjoin the IRS from enforcing Notice 2021-20 under 5 U.S.C. § 706(2)(A).
  • Similar to the Second Cause of Action, they state that this count does not seek to enjoin tax collection or refunds for clients but challenges the IRS’s compliance with the APA.
• Unlawful Agency Action (Fourth Cause of Action)
  • The plaintiffs assert that Notice 2021-20 constitutes unlawful agency action under 5 U.S.C. § 706(2)(A) & (C) because the IRS acted in excess of its statutory jurisdiction, authority, or limitations and short of statutory right.
  • They argue that Congress did not authorize the IRS to make substantive rules for the ERC, replace the congressional definition of “non-service” wages, eliminate or modify the Government Orders Test, or narrowly construe the causal relationship between COVID orders and business suspension.
  • They contend that the CARES Act and subsequent ERC legislation are clear and unambiguous in not granting the IRS such authority.
  • Because Notice 2021-20 adopts substantive positions inconsistent with Congressional command, the IRS acted beyond its authority.
  • They request the court to enjoin the IRS from enforcing Notice 2021-20 under 5 U.S.C. § 706(2)(A) & (C).
  • Again, they clarify that this cause of action does not aim to impede tax collection or secure refunds for other clients, focusing solely on the IRS’s adherence to legal boundaries.

In summary, the plaintiffs in both cases are seeking direct refunds of their claimed ERC amounts and are concurrently challenging the validity of IRS Notice 2021-20 on the grounds that it was issued in violation of the APA, is arbitrary and capricious, and exceeds the IRS’s statutory authority. They argue that the Notice unlawfully restricts ERC eligibility and credit calculations beyond what Congress intended in the CARES Act and subsequent legislation.

Details of the Plaintiff’s Claims to Have Met the Partial Suspension Test

Hammill Manufacturing Co. argues that the government orders they cite created a partial suspension of their business by compelling them to implement measures that reduced their operational capacity. The details of their arguments are as follows:

• Decreased machining hours due to on-shift temperature checks.
• Compliance with workplace sanitization mandates.
• Increased absences due to compelled quarantines.

As a result of these measures, Hammill Manufacturing Co. states that their machining hours decreased by ten percent (10%) or more in each relevant calendar quarter of 2020 and 2021. Based on this impact, they contend that they qualified for the ERC under the Government Order Test.

R.L. Morrissey & Associates, Inc. and American Ring Manufacturing, Inc. (treated as a single employer for ERC purposes) argue that government orders led to a partial suspension of their business operations in both their sales and manufacturing aspects. Their arguments include:

• Cancellation of trade shows and other sales and marketing events that were previously relied upon to generate new business, due to orders limiting group meetings.
• Modification of sales practices from in-person sales calls to less effective methods like telephone/video conferences and email solicitations due to social distancing mandates and capacity restrictions.
• For their manufacturing side (American Ring), spacing and occupancy restrictions led to reduced efficiency and diminished output on their manufacturing lines.
• Excessive absences due to forced quarantines and self-isolation of employees further impacted their manufacturing output.

As a consequence of these conditions, the Plaintiffs experienced a significant decline in operating metrics, including gross receipts. They assert that these factors demonstrate a partial suspension of their business due to compliance with government-issued orders, thus qualifying them for the ERC under the Government Order Test for the first and second calendar quarters of 2021.

The text of the filings are linked to below from TaxNotes’ free tax research service:

• Hammill Manufacturing Co. v. United States
• R.L. Morrissey & Associates Inc. v. United States

Prepared with assistance from NotebookLM.