Businesses that received Employee Retention Credit refunds that are now being examined by the IRS must preserve a sophisticated and powerful legal argument that strikes at the heart of the agency’s authority to use its standard assessment power to reclaim the cash portion of your ERC refund.
This argument comes with a critical procedural catch. Because of a well-established judicial rule called the Variance Doctrine, taxpayers pursuing disallowed refund claims in court will likely lose the right to make this argument unless it is first raised during the administrative audit or appeal with the IRS. This is a step that, especially before the Independent Office of Appeals, may seem counterintuitive but is absolutely necessary.
The Employee Retention Credit is unique because, for most eligible employers, it resulted in a cash refund because the amount of the Credit exceeded the payroll taxes owed. And because of the challenging development of the program rules and dissemination of information about ERC, many businesses had fully paid those taxes to the IRS before claiming the Credit. The amount ultimately refunded is considered the non-rebate portion of the Credit. That means when the IRS audits and disallows an ERC claim, it seeks to recover these funds by making an assessment, as if it were instead underpaid tax.
Here is the central legal challenge: Does the Internal Revenue Code or other statute authorize the IRS to make this assessment? A strong legal argument can be made that no law allows for this action. The authority the IRS is relying on comes from its own regulations, not directly from a statute passed by Congress. The argument, therefore, is that the IRS’s regulations are an overreach of its authority. And with the Supreme Court’s decision in Loper Bright v. Romando, it is more likely than ever that a court will determine that the Service overreached when it gave itself the ability to assess this Credit as unpaid tax.
Essentially, the Service lacks authority under 26 U.S.C. § 6201 to make the necessary assessment of tax to recapture the Credits already paid. The Government generally, and the Service specifically, point to Section 2301(l) of the CARES Act as authorizing it to make regulations relative to the Credit. However, this section of the Act only provided that the Treasury had authority to issue procedural guidance and regulations related to advance payments of the Credit.
This was a little used provision of the Act which allowed businesses to get payments of the Credit for wages they paid prior to filing the quarter’s Form 941 by filing Form 7200. Most claims for the Credit were, however, made after the end of quarter by filing either an original Form 941 or Form 941-X. Later in the Taxpayer Certainty and Disaster Tax Relief Act, and codified at 26 U.S.C. § 3134(m), Congress gave the Treasury the authority to make regulations to prevent the “. . . avoidance of the purposes of the limitations under this section . . . ”; however, again, this was a very narrowly tailored provision that does not give the Treasury the latitude it now claims.
Therefore, the regulations ultimately promulgated at 26 C.F.R. § 31.3111-6 granting the Service authority to assess Credits paid as a tax, which base their authority in Section 2301(l), are an extreme overreach of the Treasury’s authority. Furthermore, the general authority of the Treasury to make regulations under 26 U.S.C. § 7805(a) cannot support these regulations either. If it did, that provision of the Code would essentially allow the Treasury to, by regulation, create its own system of taxation. That reading is neither supported by the law nor court precedent. In essence, the government decided it would be too hard to use the tools Congress gave it, for example through erroneous refund suits. Instead, the government puts the burden back on the taxpayer to prove that they really do deserve the refund they already received.
If taxpayers under audit want to be able to make this argument, they must first present it to the agency, including Appeals. This may seem counterintuitive because Appeals Officers are not permitted by Treasury regulations from considering the argument that regulations are not valid and so taxpayers are almost certainly going to be ignored. See 26 C.F.R. § 301.7803-2(c)(19).
So why make the argument? Because the courts demand it. A recent case, Trail King Industries, Inc. v. United States, No. 4:24-cv-04164-RAL, 2025 WL 2084112, (D.S.D. Jul. 24, 2025), serves as a stark warning. In that case, the court refused to even consider the taxpayer's challenge to the validity of a regulation because the taxpayer had not included that specific challenge in its initial administrative claim. The court ruled that the Variance Doctrine barred the argument, effectively foreclosing on the taxpayer's most creative line of attack. The court indicated that the Variance Doctrine is a judicially created bar and whether Treasury regulations allow for the IRS to consider an argument does not affect judicially created doctrines.
The lesson from Trail King is clear: To preserve the right to challenge the IRS's assessment authority in front of a judge who can adjudicate the issue, taxpayers must first present the argument to the Independent Office of Appeals, even if it is a literal exercise in futility.
This is a complex, in-the-weeds legal argument that requires careful execution. If you are facing an ERC audit after having received a refund, it is imperative to consult tax counsel who understands both the nuances of the Credit and the sometimes-unforgiving rules of tax litigation. Including this argument in your protest, or claim for refund, is a critical defensive step to ensure all your legal options remain available down the road. Contact our team today at (410) 497-5947 or schedule a confidential consultation.
%20(1).png)
Businesses that received Employee Retention Credit refunds that are now being examined by the IRS must preserve a sophisticated and powerful legal argument that strikes at the heart of the agency’s authority to use its standard assessment power to reclaim the cash portion of your ERC refund.
This argument comes with a critical procedural catch. Because of a well-established judicial rule called the Variance Doctrine, taxpayers pursuing disallowed refund claims in court will likely lose the right to make this argument unless it is first raised during the administrative audit or appeal with the IRS. This is a step that, especially before the Independent Office of Appeals, may seem counterintuitive but is absolutely necessary.
The Employee Retention Credit is unique because, for most eligible employers, it resulted in a cash refund because the amount of the Credit exceeded the payroll taxes owed. And because of the challenging development of the program rules and dissemination of information about ERC, many businesses had fully paid those taxes to the IRS before claiming the Credit. The amount ultimately refunded is considered the non-rebate portion of the Credit. That means when the IRS audits and disallows an ERC claim, it seeks to recover these funds by making an assessment, as if it were instead underpaid tax.
Here is the central legal challenge: Does the Internal Revenue Code or other statute authorize the IRS to make this assessment? A strong legal argument can be made that no law allows for this action. The authority the IRS is relying on comes from its own regulations, not directly from a statute passed by Congress. The argument, therefore, is that the IRS’s regulations are an overreach of its authority. And with the Supreme Court’s decision in Loper Bright v. Romando, it is more likely than ever that a court will determine that the Service overreached when it gave itself the ability to assess this Credit as unpaid tax.
Essentially, the Service lacks authority under 26 U.S.C. § 6201 to make the necessary assessment of tax to recapture the Credits already paid. The Government generally, and the Service specifically, point to Section 2301(l) of the CARES Act as authorizing it to make regulations relative to the Credit. However, this section of the Act only provided that the Treasury had authority to issue procedural guidance and regulations related to advance payments of the Credit.
This was a little used provision of the Act which allowed businesses to get payments of the Credit for wages they paid prior to filing the quarter’s Form 941 by filing Form 7200. Most claims for the Credit were, however, made after the end of quarter by filing either an original Form 941 or Form 941-X. Later in the Taxpayer Certainty and Disaster Tax Relief Act, and codified at 26 U.S.C. § 3134(m), Congress gave the Treasury the authority to make regulations to prevent the “. . . avoidance of the purposes of the limitations under this section . . . ”; however, again, this was a very narrowly tailored provision that does not give the Treasury the latitude it now claims.
Therefore, the regulations ultimately promulgated at 26 C.F.R. § 31.3111-6 granting the Service authority to assess Credits paid as a tax, which base their authority in Section 2301(l), are an extreme overreach of the Treasury’s authority. Furthermore, the general authority of the Treasury to make regulations under 26 U.S.C. § 7805(a) cannot support these regulations either. If it did, that provision of the Code would essentially allow the Treasury to, by regulation, create its own system of taxation. That reading is neither supported by the law nor court precedent. In essence, the government decided it would be too hard to use the tools Congress gave it, for example through erroneous refund suits. Instead, the government puts the burden back on the taxpayer to prove that they really do deserve the refund they already received.
If taxpayers under audit want to be able to make this argument, they must first present it to the agency, including Appeals. This may seem counterintuitive because Appeals Officers are not permitted by Treasury regulations from considering the argument that regulations are not valid and so taxpayers are almost certainly going to be ignored. See 26 C.F.R. § 301.7803-2(c)(19).
So why make the argument? Because the courts demand it. A recent case, Trail King Industries, Inc. v. United States, No. 4:24-cv-04164-RAL, 2025 WL 2084112, (D.S.D. Jul. 24, 2025), serves as a stark warning. In that case, the court refused to even consider the taxpayer's challenge to the validity of a regulation because the taxpayer had not included that specific challenge in its initial administrative claim. The court ruled that the Variance Doctrine barred the argument, effectively foreclosing on the taxpayer's most creative line of attack. The court indicated that the Variance Doctrine is a judicially created bar and whether Treasury regulations allow for the IRS to consider an argument does not affect judicially created doctrines.
The lesson from Trail King is clear: To preserve the right to challenge the IRS's assessment authority in front of a judge who can adjudicate the issue, taxpayers must first present the argument to the Independent Office of Appeals, even if it is a literal exercise in futility.
This is a complex, in-the-weeds legal argument that requires careful execution. If you are facing an ERC audit after having received a refund, it is imperative to consult tax counsel who understands both the nuances of the Credit and the sometimes-unforgiving rules of tax litigation. Including this argument in your protest, or claim for refund, is a critical defensive step to ensure all your legal options remain available down the road. Contact our team today at (410) 497-5947 or schedule a confidential consultation.
