ERC Audits in 2026: Defending Pandemic-Era Credit Claims

The Employee Retention Credit went out fast, roughly $283 billion of it, and the IRS now has six years to take some back. The One Big Beautiful Bill Act, signed into law July 4, 2025, extended the assessment period for third- and fourth-quarter 2021 ERC claims to six years and barred payment after that date on any claim for those quarters filed after January 31, 2024. As a result, a 2023 claim for the third quarter of 2021 can stay open to an ERC audit into 2029.

Where Enforcement Stands

The GAO reported in February 2026 that the IRS never produced an improper-payment estimate for the credit. Reporting since then puts about 41,000 claims still in examination or appeals. IRS-CI had opened 588 criminal ERC investigations through September 30, 2025, involving more than $5.6 billion in claims, and 108 had already produced federal charges. The largest indictment, filed in the Eastern District of New York in January 2025, charged seven defendants over more than $600 million in claims.

The 2025 law also reaches the marketing firms that sold the credit. A firm that charged fees tied to the size of the credit and drew a large share of its receipts from ERC work now faces a $1,000 penalty for each due diligence failure, as the IRS’s OBBBA ERC FAQs describe. The IRS had fired a warning shot at these firms years earlier.

How Courts Read Eligibility

Enough ERC refund suits have been decided now to show what an eligibility argument needs. The credit turned on a full or partial suspension of operations “due to” a government order, and our ERC primer walks through the original tests. A Tennessee federal court read “due to” as requiring both but-for and proximate causation in JPM Restaurant, LLC v. United States (E.D. Tenn. Feb. 27, 2026). In Sundancer Pools, Inc. v. United States (Fed. Cl. June 23, 2026), the court held that a partial suspension means stopping more than a nominal portion of operations. Lost productivity and staffing trouble aren’t enough, and a supply-chain theory fails without a government order as the proximate cause.

But pleading matters as much as proof. In I Health & Life Insurance Services v. United States (Fed. Cl. July 23, 2026), the court allowed a business to amend and identify the California orders it relied on, while the government counterclaimed for about $400,000 paid on a different quarter. Filing a refund suit puts every paid quarter back on the table. The government, for its part, can sue to recover an erroneous refund under section 7405, a route a Mississippi federal court confirmed in Plastic Film, LLC v. United States, though it required the government to plead specific facts showing ineligibility.

Why Investigate First?

Most problem claims share an origin story. A marketing firm filed amended Forms 941-X on a contingency fee, the credit arrived, and the firm moved on. Before answering an IRS letter or deciding whether to repay, the business needs to know what was claimed, for which quarters, and on what theory. Depending on the situation, counsel may need to run it.  If so, counsel should retain accountants under a Kovel arrangement, because an accountant’s workpapers aren’t privileged on their own.

The answer sorts the business into one of a few positions. If the claim was never paid, the IRS claim withdrawal program is still open. If it was paid and the theory doesn’t hold up, the two voluntary disclosure programs that allowed repayment at 80 and 85 percent without penalties closed in 2024, which leaves correcting the claim on an amended return or defending it. If the theory is sound, the work lies in building the record: the specific orders, their dates, and the operations they stopped. Our forensic accounting and investigations attorneys can assist with that reconstruction.

After a Disallowance

A Letter 105C disallowance starts a two-year clock under section 6532(a) to sue for a refund. The IRS sends Notice CP320B when six months or less remain, and Form 907 can extend the period. Note that IRS Appeals averaged 337 days per case in fiscal 2025, according to the National Taxpayer Advocate. So don’t let the suit deadline lapse while the case sits in IRS Appeals.

The income tax side should be considered too. Section 280C(a) required reducing the wage deduction by the credit in the year the wages were paid. If the credit is disallowed, the business can increase its wage expense in the year the disallowance becomes final or amend the original year. If the facts point to a deliberately false claim rather than a mistaken one, a taxpayer should consult criminal tax defense counsel.