The Employee Retention Credit: A Promise, a Controversy, and a Ticking Clock

When Congress created the Employee Retention Credit (ERC) during the COVID-19 pandemic, it was one of the most generous relief programs in American tax history. Businesses that retained employees during the economic disruptions of 2020 and 2021 were entitled to refundable payroll tax credits worth up to $26,000 per employee. For many small and mid-sized businesses, these credits were a lifeline.

Fast-forward to 2026, and that lifeline has become a legal minefield, complete with IRS mass disallowances, a federal court battle, and a deadline that is silently expiring for thousands of businesses right now.

What the IRS Did and Why It's Controversial

Beginning in 2023, the IRS grew increasingly concerned about fraudulent ERC claims promoted by aggressive third-party preparers. In response, the agency developed an automated "risking model," an algorithmic system that categorically flagged and denied tens of thousands of claims without individualized review. In the summer of 2024 alone, the IRS issued approximately 28,000 disallowance notices, many generated by this automated process rather than by human examiners reviewing actual business records.

Businesses receiving these denials (via IRS Letter 105-C for full disallowance or Letter 106-C for partial disallowance) were understandably confused and frustrated. Many had legitimate claims that the algorithm incorrectly flagged. They filed protests with the IRS Independent Office of Appeals, and waited.

The Ninth Circuit Case: Legal Vulnerability Left Wide Open

Two tax preparation firms challenged the IRS's automated disallowance program in federal court (ERC Today, LLC v. McInelly, Case No. 25-2642, 9th Cir. Mar. 17, 2026). They argued the IRS's bulk disallowance methodology violated the Administrative Procedure Act and was otherwise unlawful.

The Ninth Circuit affirmed the lower court's denial of a preliminary injunction, but critically, on standing grounds only. The court found that the tax preparation firms, as third parties, lacked the legal standing to challenge the program on behalf of their clients. The court did not rule that the IRS's automated disallowance program was lawful. That question, whether the IRS can legally deny thousands of claims through an algorithm without individualized review, remains entirely unresolved.

This matters enormously. Taxpayers whose claims were disallowed, unlike the third-party firms, do have standing to challenge the methodology directly. As the court noted, a challenge brought by a party with proper standing "might reveal the program to be infirm." In other words, the legal door is still open, but you need to preserve your right to walk through it.

The Critical Two-Year Deadline and Why It May Have Already Started Running

Here is where things become urgent for businesses that received disallowance letters.

Under IRC § 6532(a), you have two years from the date of your disallowance letter to either:

• Reach an agreement with the IRS and receive your refund, or
• File a refund suit in U.S. District Court or the U.S. Court of Federal Claims.

Here is the trap: filing a protest with the IRS Independent Office of Appeals does NOT stop this clock. Many businesses have been diligently working through the administrative process, exchanging documentation with IRS reviewers and Appeals Officers, believing they had time. But the two-year period continued running in the background. When it expires, the IRS is legally barred from paying the refund, even if Appeals later rules in your favor. As the IRS itself states: "If you do not file suit within the 2-year period, or do not enter into a written extension agreement before it expires, the IRS cannot issue a refund or credit, even if Appeals later issues a favorable decision."

If your disallowance letter was dated in summer or fall of 2024, your deadline may be approaching within months.

The One Big Beautiful Bill Adds Another Hard Deadline

As if the two-year clock were not enough, Section 70605(d) of the One Big, Beautiful Bill Act created an additional hard cutoff: no ERC credit or refund for the last two quarters of 2021 is allowed after July 4, 2025, unless the claim was filed on or before January 31, 2024. If your claim covers Q3 or Q4 2021 and was filed after that date, you may face additional challenges. Documentation proving your original filing date (certified mail receipts, postmarks, electronic submission confirmations) is critical.

The IRS's New Solution: Form 907

Recognizing that many businesses are approaching the end of their two-year period while still waiting for IRS review, the IRS announced on April 27, 2026 (IR-2026-58) a new streamlined process for eligible taxpayers.

If you:

1. Received a disallowance via Letter 105-C or 106-C, and
2. Filed a response/protest that the IRS has not yet acted on, and
3. Have six months or less remaining in your two-year period,

...you may be eligible to submit Form 907, Agreement to Extend the Time to Bring Suit, via the IRS Document Upload Tool at IRS.gov/DUTReply (select "CP320B" from the dropdown).

The IRS will also be sending Notice CP320B directly to businesses it has identified as eligible. However, you should not wait for this notice. If you believe you qualify, you can submit Form 907 proactively.

Critical details:

• The extension is not valid until both you and the IRS sign Form 907
• The form must be fully executed before your two-year period expires
• Extensions are generally for up to two years and can be renegotiated if needed
• Businesses with cases assigned to an Appeals Officer should contact that officer directly

The form has strict technical requirements: all fields must be completed, a Statement of Issues must accompany the form, and if a representative is signing, a copy of Form 2848 (Power of Attorney) must be included.

What Should Your Business Do Right Now?

Step 1: Determine your deadline. Locate your Letter 105-C or Letter 106-C. The two-year period runs from the date printed on that letter, not the date you received it. If you cannot find the letter, your tax professional can obtain this information from your IRS transcript.

Step 2: Act if you have six months or less. If your deadline is within six months, consider filing Form 907 immediately. Do not wait for Notice CP320B. The IRS may not identify every eligible taxpayer.

Step 3: Consult a qualified tax professional. The Form 907 process, the Statement of Issues, and the decision to pursue litigation versus continued administrative resolution require professional guidance. Randall Parker, MBA has extensive experience guiding businesses through IRS compliance issues. Errors on the form can delay processing and potentially jeopardize the extension.

Step 4: Preserve documentation. Keep all records supporting your original ERC claim, including payroll records, government orders demonstrating partial suspension, gross receipts documentation, and proof of original filing. These will be essential for any administrative or judicial resolution.

Step 5: Consider litigation if warranted. For businesses with substantial disallowed credits, filing a refund suit in U.S. District Court or the Court of Federal Claims may be the right path, particularly given the unresolved legal questions about the IRS's automated disallowance methodology. Taxpayers who challenge the risking model on the merits could potentially establish that the mass disallowance approach itself was unlawful.

The Bottom Line

The Employee Retention Credit saga is not over. The IRS may have closed the processing window as of December 31, 2025, but businesses with disallowed claims still have rights and, potentially, significant money on the table. But those rights have an expiration date.

If you received a Letter 105-C or 106-C and have not yet resolved your claim, the time to act is now, not next month, not after tax season.

Contact Randall Parker, MBA for a consultation to review your ERC situation, evaluate your deadlines, and determine the best path forward for your business. You may also find our tax law updates and financial consulting services helpful as you navigate this process.