This article delves into the recent case of ERC Today LLC, et al. v. John McInelly, et al., No. CV-24-03178-PHX-SMM (D. Ariz. Apr. 7, 2025), providing a detailed analysis relevant to CPAs in tax practice who advise clients on Employee Retention Credit (ERC) claims. The case examines the Internal Revenue Service’s (IRS) moratorium on processing ERC claims and its implementation of a "risk assessment model," ultimately leading to the denial of a preliminary injunction sought by tax preparation firms.

Background and Facts of the Case

The ERC, codified in 26 U.S.C. § 3134, was enacted in 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES Act) to provide financial stimulus to businesses impacted by governmental pandemic restrictions and to encourage employee retention. Initially, the credit equaled 50% of qualified wages, with a maximum of $5,000 per employee annually, for employers experiencing either a full or partial suspension of operations due to government orders or a significant decline in gross receipts (50% compared to the same quarter in 2019). The ERC is both refundable and nonrefundable.

Congress amended the ERC statute three times between March 2020 and November 2021. Key changes included the Taxpayer Certainty and Disaster Tax Relief Act which increased the credit to 70% of qualified wages (up to $7,000 per employee per quarter for wages paid after December 1, 2020, and before September 30, 2021, for non-recovery startup businesses), lowered the gross receipts decline threshold to 20%, and introduced "recovery startup businesses" as eligible employers. The Infrastructure Investment and Jobs Act in November 2021 retroactively limited ERC eligibility for the fourth quarter of 2021 and beyond to only recovery startup businesses.

Employers could claim the ERC retroactively by filing Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. The paper-based filing requirement for Form 941-X led to significant processing delays due to the need for manual transcription. Faced with a surge in ERC claims and concerns about aggressive marketing and potentially fraudulent claims, the IRS had to modify its data capture and claim selection methods. By the end of 2023, the backlog of unprocessed ERC claims requiring further review exceeded 1.1 million.

In September 2023, the IRS instituted a moratorium on processing new ERC claims to address the backlog and evaluate processing procedures. During this period, the IRS continued to process existing claims at a slower rate. The Treasury Inspector General for Tax Administration (TIGTA) issued a report in September 2024, highlighting that the IRS’s expedited claim review between January 2022 and June 2023 may have resulted in the payment of hundreds of millions of dollars in potentially erroneous ERC. The TIGTA report also noted the IRS’s lack of readily available data to verify employer eligibility based on government orders, gross receipts decline, or qualified wages.

During the moratorium, the IRS implemented a new ERC processing protocol identified as "’Disallowance During Processing,’" where automated systems were used to deny claims based on undisclosed software "filters". The IRS described this as a "risk assessment model" or "risking," which categorizes returns by risk level using entity-level filters and publicly available information (including state closure orders) to predict the likelihood of a claim’s validity. High-risk claims were designated for automated disallowance without individual review.

Following the lifting of the moratorium in August 2024, the IRS began issuing notices of disallowance in the form of Letter 105-C (full disallowance) and Letter 106-C (partial disallowance). Letter 105-C typically stated that the recipient was not an Eligible Employer because IRS records indicated no relevant government orders or a failure to meet the gross receipts decline threshold. These letters also informed recipients of their right to appeal the decision administratively or file suit in U.S. District Court or the U.S. Court of Federal Claims within two years from the date of the notice.

The plaintiffs in this case, ERC Today LLC and Stenson Tamaddon LLC, are tax preparation firms that assist businesses in filing ERC claims. They alleged that the IRS’s new policy of automated denials resulted in rejections of clearly eligible claims without individualized review, harming their businesses as their income is derived from successful ERC refunds obtained for their clients.

Plaintiffs’ Request for Relief

The plaintiffs sought a preliminary injunction compelling the IRS to:

Cease issuing summary denials of ERC claims based on automatic filters.
Restore prior ERC processing procedures.
Provide adequate notice of deficiencies and appellate rights.
Rescind previous denials issued under improper processing procedures.
Provide an accounting of Form 105-C disallowances issued under the "Disallowance During Processing" procedures.

Court’s Legal Analysis

The court analyzed the plaintiffs’ motion for a preliminary injunction based on the four factors established in Winter v. Nat. Res. Def. Council, Inc., 555 U.S. 7, 30 (2008): (1) likelihood of success on the merits, (2) likelihood of irreparable harm absent the injunction, (3) balance of equities tipping in the movant’s favor, and (4) whether the injunction is in the public interest. However, the court first addressed the issue of Article III standing.

Article III Standing

To establish standing, a plaintiff must demonstrate (i) an injury in fact, (ii) causation, and (iii) redressability (Food & Drug Admin. v. All. for Hippocratic Med., 602 U.S. 367, 378 (2024)).

Injury: The court found that the plaintiffs demonstrated a sufficient injury in fact, as they suffer monetary harm when their clients’ ERC claims are denied due to their percentage-of-recovery fee model and contractual obligations to assist with appeals without additional compensation (Fair v. EPA, 795 F.2d 851, 853 (9th Cir. 1986); TransUnion LLC v. Ramirez, 594 U.S. 415, 425 (2021)).
Causation: The court also found causation, rejecting the IRS’s argument that the injury was due to the plaintiffs’ business model. The court reasoned that the denial of clients’ claims by the IRS directly leads to the plaintiffs not receiving fees (Murthy v. Missouri, 603 U.S. 43, 57–58 (2024); Federal Election Comm’n v. Cruz, 596 U.S. 289, 297 (2022)).
Redressability: Crucially, the court found that the plaintiffs failed to make a clear showing of redressability. The court reasoned that even if the IRS were enjoined from using the "risking" model and compelled to return to prior procedures, it was speculative whether this would lead to a higher rate of approved ERC claims for the plaintiffs’ clients. The court highlighted the TIGTA report’s findings that the IRS’s expedited review process prior to the moratorium may have resulted in the approval of ineligible claims. The court concluded that the record did not support the claim that the IRS was now disallowing eligible claims; instead, it suggested the IRS was likely correcting for previously over-approved ineligible claims.

Sovereign Immunity (APA Claims)

The plaintiffs brought several claims under the Administrative Procedure Act (APA), 5 U.S.C. § 702. The APA waives sovereign immunity for actions seeking relief other than money damages, where there is no other adequate remedy, and the action is not expressly or impliedly forbidden by another statute. A key requirement for judicial review under the APA is that the challenged agency action must be "final" (5 U.S.C. § 704). A final agency action (1) must mark the consummation of the agency’s decision-making process and (2) must be one by which rights or obligations have been determined or from which legal consequences will flow (Bennett v. Spear, 520 U.S. 154, 177–78 (1997)).

The court determined that the IRS’s procedures for processing ERC claims, including the "risking" model, did not constitute a final agency action. The court reasoned that the "consummation" of the decision-making process is the allowance or disallowance of individual ERC claims, not the process used to review them. Furthermore, the court noted that employers whose ERC claims are disallowed have alternative remedies, such as administrative appeals and lawsuits in federal court, thus negating the waiver of sovereign immunity under 5 U.S.C. § 702. Therefore, the court lacked jurisdiction to consider the plaintiffs’ APA claims (Navajo Nation v. Dep’t of the Interior, 876 F.3d 1144, 1170 (9th Cir. 2017)).

Fifth Amendment Due Process Claim

The plaintiffs also asserted a Fifth Amendment substantive due process claim, arguing that the IRS’s procedures arbitrarily denied their clients’ protected property interests in tax refunds. The court first addressed whether the requested injunction was mandatory or prohibitory. Finding that the relief sought included actions beyond maintaining the status quo (such as restoring prior procedures and vacating denials), the court characterized the injunction as mandatory, which is subject to a higher standard requiring a clear showing of extreme or very serious damage and that the merits of the case are not doubtful (Anderson v. United States, 612 F.2d 1112, 1114-15 (9th Cir. 1979); Hernandez v. Sessions, 872 F.3d 976, 999 (9th Cir. 2017)).

Turning to the likelihood of success on the merits of the due process claim, the court found that the plaintiffs failed to establish two key elements:

Constitutionally Protected Property Interest: The court questioned whether the plaintiffs’ clients had a constitutionally protected property interest in their unapproved tax credit claims (Daniels v. Williams, 474 U.S. 327, 331 (1986); Cnty. of Sacramento v. Lewis, 523 U.S. 833, 846 (1998)).
Standing to Assert Clients’ Rights: The court held that the plaintiffs generally must assert their own legal rights and interests and cannot base their claim on the rights of third parties (Warth v. Seldin, 422 U.S. 490, 499 (1975)). The court rejected the plaintiffs’ argument that their clients were hindered from independently bringing a due process claim due to financial disincentives, distinguishing the case from Powers v. Ohio, 399 U.S. 400 (1991).

Because the plaintiffs did not establish a likelihood of success on the merits of their substantive due process claim, the court did not need to consider the remaining Winter factors.

Court’s Conclusions

The court ultimately denied the plaintiffs’ motion for a preliminary injunction . The primary reason for the denial was the plaintiffs’ failure to make a clear showing of Article III standing, specifically regarding redressability. The court was not persuaded that compelling the IRS to change its processing procedures would likely lead to the approval of the plaintiffs’ clients’ claims and thus redress the plaintiffs’ alleged injuries. Additionally, the court found that the plaintiffs were unlikely to succeed on their APA claims due to the lack of a final agency action and the availability of other adequate remedies for taxpayers. Finally, the court concluded that the plaintiffs had not demonstrated a likelihood of success on their substantive due process claim. The court noted that the taxpayers (the plaintiffs’ clients) have recourse through administrative appeals and lawsuits to challenge the disallowance of their ERC claims.

Implications for CPAs in Tax Practice

This case highlights several important considerations for CPAs advising clients on ERC claims:

Understanding IRS Processing Procedures: CPAs should be aware of the IRS’s evolving ERC claim processing methods, including the moratorium and the implementation of risk assessment models. While the specific filters used by the IRS remain undisclosed, understanding the agency’s focus on identifying high-risk claims is crucial.
Managing Client Expectations: Given the IRS’s increased scrutiny and the potential for automated denials, CPAs should manage client expectations regarding the likelihood and timing of ERC refunds. It is important to emphasize the eligibility requirements and the need for robust documentation.
Importance of Thorough Due Diligence: The IRS’s focus on erroneous claims underscores the importance of CPAs conducting thorough due diligence to ensure clients meet all ERC eligibility criteria. This includes a careful analysis of government orders and gross receipts declines.
Navigating Disallowance Notices: CPAs must be prepared to assist clients in understanding disallowance notices (Letters 105-C and 106-C) and the available options for appeal or litigation. The court’s mention of these avenues of recourse is significant.
Limitations on Third-Party Standing: This case reinforces the principle that tax advisors generally do not have standing to directly challenge IRS procedures on behalf of their clients in the same manner as the taxpayers themselves.

While ERC Today LLC did not succeed in obtaining a preliminary injunction, the case provides valuable insights into the legal challenges surrounding the IRS’s administration of the ERC and underscores the importance of diligent claim preparation and understanding the available taxpayer remedies in case of a disallowance. CPAs should stay informed of further developments in ERC administration and related litigation.

Prepared with assistance from NotebookLM.

The text of the ruling can be read via the link below:

ERC Today LLC, et al. v. John McInelly, et al., No. CV-24-03178-PHX-SMM (D. Ariz. Apr. 7, 2025