IRS Employee Retention Credit Disallowance Protest

The situation

Sandra, 52, owns Riverside Grill, a sit-down restaurant in Sacramento, CA (28 tables, $1.4M annual pre-COVID revenue). During 2020-2021, California issued multiple executive orders restricting or eliminating indoor dining:

- March 19, 2020 – May 2020: All indoor dining prohibited; takeout/delivery only - July 2020 – late 2020: Indoor dining re-closed in Sacramento County; limited outdoor only - Q3 2021: 50% indoor capacity limit with state certification requirements

Sandra's original ERC claim (prepared by her bookkeeper): $148,000 in ERC refunds for Q2 2020, Q3 2020, Q4 2020, Q1 2021, Q2 2021 (seven quarters total).

In November 2024 Sandra received IRS Letter 105-C: "We have determined that your claim for refund for the Employee Retention Tax Credit does not meet the requirements for the credit. Your claim is disallowed in full, $148,000."

The IRS's basis: "Your business continued operating during the quarters claimed; takeout service was available. You do not meet the 'fully or partially suspended' test."

Sandra has approximately two years from the November 2024 mailing date (so until approximately November 2026) to protest with IRS Appeals.

(a) The IRS is wrong on the government orders test for at least four of Sandra's seven quarters. The "more than nominal" suspension test doesn't require the business to be fully closed, it requires that government orders reduced operations by more than 10%. Sandra's indoor dining represented approximately 85% of her pre-COVID revenue. During the quarters when indoor dining was prohibited, her operations were reduced by far more than 10%. The relevant California Executive Orders (EO N-33-20, Sacramento County Health Orders) specifically prohibited indoor dining, they are government orders imposing restrictions on Sandra's category of business.

(b) The IRS disallowance letter may be based on the "risking model," not individualized review. IRS has been using a pattern-based algorithmic model to identify and disallow ERC claims en masse. If Sandra's disallowance was algorithm-driven (common for restaurant claims in California), the protest should specifically demonstrate that her restaurant's specific location was subject to specific government orders during specific quarters, individualized documentation that the algorithm cannot evaluate.

(c) The gross receipts test is a backup argument for at least Q3 2020. Sacramento County reimposed restrictions in July 2020. Sandra's Q3 2020 gross receipts were approximately $182,000 (vs. $387,000 in Q3 2019), a 53% decline. Even if the government orders test somehow fails, Sandra's Q3 2020 claim qualifies under the gross receipts test (>50% decline vs. 2019 for 100% ERC credit rate).

(d) Sandra needs a government orders log + quarterly gross receipts comparison for the protest. The most persuasive ERC protest submission includes: (i) a quarterly grid mapping each claimed quarter to specific government order in effect to effect on the business (indoor dining closed/restricted); (ii) quarterly gross receipts comparison (2019 vs. 2020/2021); (iii) documentation of Sandra's specific business model (dine-in dependent, not primarily takeout/delivery). A tax attorney quoted Sandra $7,500 for ERC disallowance protest preparation and Appeals representation. These are structured analytical tasks Sandra can largely do herself with the right framework.

Second portrait: David, 44, owns Premier Event Rentals LLC (Nashville, TN, $2.2M revenue), a wedding and corporate event equipment rental company. David's ERC claim: $112,000 for Q2 2020 – Q2 2021. IRS Letter 106-C partially disallowed $89,000 (kept $23,000). The IRS's basis: "Most quarters do not meet the government orders test because you were permitted to operate."

David's defense: Tennessee limited gatherings to 10 people through most of Q2-Q3 2020 (Governor Lee's executive orders). Event rental businesses, which depend on large gatherings of 50-500+ people, were effectively suspended by 10-person gathering limits. The "government order" suspending gatherings INDIRECTLY suspended David's business operations even though equipment rental companies were not directly named in the order. The IRS's "partial suspension" test covers businesses that were INDIRECTLY affected by government orders on their customers' gatherings.

Who receives this

Small business owners who received IRS Letter 105-C (full disallowance) or 106-C (partial disallowance) of their Employee Retention Credit claims. Primary segments: (1) Restaurants and food service businesses that operated under indoor dining restrictions; (2) Events, hospitality, and entertainment businesses affected by gathering limits; (3) Retail businesses that operated under capacity restrictions; (4) Professional service businesses claiming partial suspension. Scale: 84,000+ disallowance letters issued; ~41,000 claims still in Examination/Appeal (late 2025); with typical ERC claims of $50,000-$300,000, the total at risk is billions of dollars across tens of thousands of businesses.

Why the agency will not advise you

The IRS ERC compliance unit cannot advise businesses how to contest its own disallowance letters. IRS Appeals is genuinely independent (IRC § 7803(e)). No self-serve ERC disallowance protest tool found. The professional market is specialized ERC defense firms and tax attorneys ($2,000-$15,000). The government orders database lookup, quarterly gross receipts comparison, and partial suspension analysis are highly structured tasks, the "more than nominal" test applies to the SPECIFIC quarter × SPECIFIC business location × SPECIFIC government order, which is a structured lookup + analysis workflow, not unstructured legal reasoning.

Key facts, with sources

• The IRS issued more than 84,000 Employee Retention Credit (ERC) disallowance letters (Letter 105-C for full disallowance; Letter 106-C for partial disallowance) between 2023 and 2025. As of late 2025, approximately 41,000 ERC claims remained in IRS Examination or Appeal. The standard protest window for most IRS disallowance letters is 30 days; however, for ERC disallowance letters, the IRS announced that businesses have TWO YEARS from the mailing date of Letter 105-C/106-C to administratively protest with the IRS Independent Office of Appeals. This two-year window aligns with the statutory period for filing a refund suit in federal district court or the Court of Federal Claims. In April 2026, the IRS announced a new streamlined Form 907 extension option, businesses with fewer than 6 months remaining in their two-year window can submit Form 907 via the IRS Document Upload Tool to extend the suit deadline while Appeals reviews the case. The IRS Independent Office of Appeals (established under IRC § 7803(e) and strengthened by the Taxpayer First Act of 2019) is structurally independent from the ERC compliance function: Settlement Officers assigned to ERC protest cases are NOT members of the ERC compliance unit; ex parte communications between the compliance unit and Settlement Officers are prohibited. IRS data indicates ERC Appeals are taking 6-18 months due to the volume of cases. Source: IRS Issues ERC Disallowance Letters — KBKG · Did You Receive a Notice of Claim Disallowance for Your ERC? — Taxpayer Advocate Service · IRS Offers Extension Option for Taxpayers Facing ERC Deadlines — Journal of Accountancy
• The most common bases for IRS ERC disallowance are: (1) Government Orders Test Not Met, IRS position is that the business was not 'fully or partially suspended' by a government order because it continued operating in some capacity (takeout during dine-in restrictions; construction continued during non-essential business restrictions; office work continued via remote work). The defense requires demonstrating that the government order had 'more than a nominal effect' on the business's operations, defined as reducing operations by more than 10% in hours, revenue, or services in the applicable quarter. (2) Gross Receipts Decline Test Not Met, IRS position is that quarterly gross receipts for the claimed quarter did not decline by >50% (2020 quarters, 100% credit rate) or >20% (2021 quarters, 70% credit rate) compared to the same quarter in 2019. The defense requires quarterly gross receipt documentation (typically Form 941, profit/loss statements, or sales tax records). The IRS has been challenged for using a 'risking model' that algorithmically denies claims without individualized review, businesses with legitimate government orders suspension claims have received disallowance letters based on the IRS model rather than individualized analysis (Tax Controversy 360, April 2025). The specialized professional market: Rockerbox (ERC audit defense), specialized tax controversy firms, and tax attorneys charge $2,000–$15,000 for ERC disallowance protest representation. No self-serve ERC disallowance protest preparation tool was found. Source: Responding to ERC-Related Disallowance Notices — RSM · The ERC: IRS's Risking Model Faces Legal Challenge — Tax Controversy 360 · How Employers Can Protest a Disallowance Notice — Rockerbox

When to bring in a professional

Self-serve responses fit routine cases: clear facts, amounts a business can absorb, and a deadline still ahead of you. Bring in a licensed professional when the amount at stake is large relative to their fee, the facts are genuinely disputed, criminal exposure is possible, or the deadline has already passed. A short paid consultation to sanity-check your plan is often worth it even when you handle the filing yourself.

All sources for this guide

1. IRS Issues ERC Disallowance Letters — KBKG
2. Did You Receive a Notice of Claim Disallowance for Your ERC? — Taxpayer Advocate Service
3. IRS Offers Extension Option for Taxpayers Facing ERC Deadlines — Journal of Accountancy
4. Responding to ERC-Related Disallowance Notices — RSM
5. The ERC: IRS's Risking Model Faces Legal Challenge — Tax Controversy 360
6. How Employers Can Protest a Disallowance Notice — Rockerbox