A federal court has upheld the IRS’s right to use automated tools to review Employee Retention Credit (ERC) claims, rejecting a challenge brought by two tax preparation firms.

In ERC Today LLC v. McInelly, the U.S. District Court for the District of Arizona ruled that the firms didn’t have standing to sue the IRS over its use of software to identify potentially invalid ERC claims. The court found that the firms couldn’t show how stopping the automated review process would fix the alleged harm they suffered — namely, the loss of contingent fees tied to clients’ ERC refunds.

As a result, the IRS can continue using its automated filters to deny claims flagged by the software as not qualified.

What’s Behind the Challenge?

The ERC, created under the CARES Act in 2020 and expanded by later laws, offers refundable tax credits to eligible employers. Claims are filed using IRS Form 941. But with initial delays due to pandemic-era office closures and programming challenges, the IRS faced a major backlog.

The backlog was compounded by a flood of questionable claims. The IRS flagged ERC scams as one of its “Dirty Dozen” tax schemes in 2023, warning that some promoters were pushing ineligible businesses to apply. In response, the IRS paused ERC processing for nearly a year — from September 2023 through August 2024.

During this period, the agency adopted a new automated procedure using an undisclosed software program that used filters to identify claims that may not qualify for ERC. The agency’s use of the software program to issue denial letters was the subject of the litigation

What Did the Court Say?

The plaintiffs claimed the automated denials violated the Administrative Procedure Act, overstepped the IRS’s statutory authority, and infringed on due process rights under the Fifth Amendment. But the court didn’t reach those arguments. Instead, it found that the plaintiffs hadn’t met the threshold requirement of standing — because even if the court ordered the IRS to stop using the software, it wouldn’t guarantee that any denied claims would be paid or that the firms would get their fees.

That’s a key takeaway: the court’s ruling wasn’t about whether the software was fair or legal, but whether the challengers had the right to sue in the first place.

What This Means for Employers

For now, the IRS’s automated review system remains in place. Employers should expect ERC claims to face extra scrutiny. If you’re unsure whether a claim you’ve submitted (or plan to submit) may be affected, or if you've received a denial, it’s important to review your situation carefully.

Employers who have questions or concerns related to ERC claims should contact a member of our Tax & Wealth Planning Department.

This information is intended to inform firm clients and friends about legal developments, including the decisions of courts and administrative bodies. Nothing in this alert should be construed as legal advice or a legal opinion. Readers should not act upon the information contained in this alert without seeking the advice of legal counsel. Views expressed are those of the author(s) and not necessarily this law firm or its clients. Prior results do not guarantee a similar outcome.