The IRS has provided additional guidance and appeal details for responding to letters disallowing Employee Retention Credit (ERC) claims. Employers seeking to preserve their claims should pay careful attention to IRS guidance on what to include in responses and expect lengthy delays in response times.
In late 2024, the IRS announced processing updates for Employee Retention Credit (“ERC”) claims, including a plan to process low-risk claims and issue letters disallowing what it considered high risk claims. The disallowances typically take the form of IRS Letter 105-C, a full disallowance of the amount claimed, or Letter 106-C, a partial disallowance.
After substantial confusion regarding how to respond to these disallowance letters, the IRS released guidance in December 2024 on how to respond to Letters 105-C, full disallowances, and, more recently, April 2025, on how to respond to Letters 106-C, partial disallowances. These pages detail the information and supporting documents needed to protest ERC disallowances and preserve the appeal rights. Taxpayers responding to these notices should pay heed to the specific information the IRS provides should be included and be careful to monitor the two-year statute of limitation date after submission.
In August 2024, the IRS announced updates to its processing methods and timeline for pending Employee Retention Credit (“ERC”) claims. This included a new priority on processing low-risk claims, while carefully reviewing and denying ERC claims identified as suspect or potentially fraudulent using a risk-scoring data analysis process. As part of this initiative, the Service began mailing letters disallowing unpaid ERC claims to businesses in late 2024, including Letter 105-C, “Disallowance of the Employee Retention Credit” and Letter 106-C, “Claim Partially Disallowed”.
According to the Taxpayer Advocate Service’s Annual Report to Congress 2024, the IRS ran ERC claims through a risk scoring model analysis and, based on these results, deemed thousands of claims invalid. The IRS then issued Letters 105-C fully disallowing those claims identified, despite never having requested supporting documentation or considering the specific facts and circumstances of the individual taxpayers. These 105-C Letters have the effect of subjecting taxpayers to a reverse audit by requiring taxpayers who disagree with the ERC disallowance to respond and support their claim with the same types of documentation that would be required in a full-blown IRS examination. The 105-C Letters direct taxpayers to support a written response seeking an appeal with the IRS Independent Office of Appeals (Appeals) if they disagree. The disallowance letters trigger a two-year window during which the taxpayer can contest the decision in court.
Many claimants and advisors were initially unclear about what information they needed to include in their response in order to properly defend their ERC claims; the language in IRS disallowance letters varied widely and did not always notify taxpayers of their appeal rights, particularly in early examples.
In December 2024, the IRS released informal guidance for taxpayers responding to Letter 105-C, including directions on what supporting documents and details should be submitted and how to preserve the taxpayer’s right to appeal the disallowance. On April 22, 2025, the IRS released new guidance for responding to Letters 106-C.
The December 2024 Letter 105-C guidance takes a step-by-step approach to help taxpayers understand the letter they have received and how best to respond. It explains that Letter 105-C will generally contain an explanation of the disallowance, reference to the tax period at issue, and an explanation of the taxpayer’s rights to appeal or file suit to challenge the disallowance. Taxpayers responding to a Letter 105-C should read the explanation carefully and review their ERC claim for accuracy and completion, and to ensure that all requirements for ERC eligibility were met. Both the Letter 105-C and the guidance specify that no further action is needed if the taxpayer agrees with the disallowance.
For taxpayers who do not agree with the disallowance of claim, the guidance provides instructions to “respond to the letter with additional documentation to support your eligibility and claim amount.” A separate section under the heading “What to send the IRS if you disagree with the disallowance” gives more detail. In general, the taxpayer’s response should first address the letter’s stated reason for the disallowance, and then provide support for the taxpayer’s ERC eligibility and calculations.
Notably, many Letters 105-C contained only a general statement under the heading “Why We Can’t Allow Your Claim” regarding the reason for the claim denial. Many Letters 105-C have been focused on ERC claims filed for the third calendar quarter of 2021 based on a stated lack of eligibility criteria, but the quarter at issue and the specific disallowance issue can vary. For this quarter, many 105-C letters stated that “Our records indicate there were no government orders related to COVID-19 in effect during the quarter(s) you claimed ERC which could have fully or partially suspended your trade or business. Our records also show you do not meet the required decline in gross receipts.”
The IRS is typically not in possession of records containing quarterly gross receipts information, which are needed to calculate gross receipts eligibility for ERC. Additionally, while there were substantially fewer COVID-19 related government orders in place in the second half of 2021, it may be an overgeneralization to say there were “no” orders. This type of disallowance appears to be an educated guess based on annual gross receipts information from the taxpayer’s annual income tax returns for 2019, 2020, and/or 2021, and a possible lack of applicable government orders.
The IRS guidance directs taxpayers responding to Letters 105-C to provide specific documentation of how the taxpayer was eligible for the ERC for the quarter at issue. If the ERC was claimed based upon a significant decline in gross receipts, then the taxpayer must provide records of the entity’s (or aggregated group’s, if applicable) gross receipts for all quarters within the tax year claimed for ERC reconciliation purposes and for all quarters of the comparison tax year (usually 2019). The guidance specifies that a summary of gross receipts alone will not be sufficient proof for eligibility; taxpayers must provide financial records, such as quarterly profit and loss statements or income statements for each year at issue, in order to prove the decline in gross receipts.
For taxpayers who claimed ERC based on a full or partial suspension of business operations due to COVID-19 related government orders, the guidance provides a different set of instructions. Specifically, in order to prove the claim, the taxpayer must produce a copy of each COVID-19 related government order that caused a suspension of operations, with the specific provision(s) highlighted; a written explanation of how each government order impacted business operations during the quarter at issue; and documents proving the orders’ impacts on the taxpayer’s business operations, including business records such as meeting minutes, employee or customer communications, etc. that show that the government order fully or partially suspended business operations.
In addition to documents in support of eligibility, all taxpayers protesting a disallowance of ERC must provide a written explanation of facts in support of the taxpayer’s entitlement to the ERC, as well as a description and summary of the entity’s trade or business operations, copies of worksheets used to compute the ERC, and a statement that confirms that these ERC calculations did not include any wages that do not count as qualified wages for ERC purposes (wages paid to related individuals, wages reported for purposes of Paycheck Protection Program (PPP) loan forgiveness, or, for large eligible employers, amounts paid to employees providing services). Finally, the response must also meet all applicable protest requirements listed in IRS Publication 5, “Your Appeal Rights and How to Prepare a Protest if You Disagree”.
Similarly, the April 2025 106-C guidance explains the meaning of the IRS letter and advises taxpayers on how to respond. Letter 106-C notifies taxpayers that the IRS has partially denied the ERC claimed for a tax period, due to a determination that the amount of the claim exceeded the credit limits for the applicable year (2020 or 2021). The 106-C letter should outline all the relevant details about the claim, including period and year, amount claimed, and amount disallowed, as well as an explanation of the taxpayer’s appeal rights. This determination to partially disallow an ERC claim could be based on a discrepancy between the claim amount and the number of employees reported, either by quarter on the Form 941 or for the full year on Forms W-2, Wage and Tax Statement. We have also seen instances where the partial disallowance appeared to stem from an IRS administrative error in processing the Taxpayer’s claim. Taxpayers would be well advised to consult with a tax advisor before responding if they are unsure of the reason for the partial disallowance.
For the most part, 106-C letters result in a partial credit, based on a calculated reduction in the claim. However, the IRS guidance notes that in some cases, the reduction in credit calculated could, in effect, deny the entire quarter’s claim. In the scenario where a 106-C reflects zero credit allowed, the guidance directs taxpayers to instead follow the instructions, summarized above, for responding to Letter 105-C to prove the entire credit.
Otherwise, taxpayers should respond in writing to the reason for disallowance listed in the Letter 106-C. The guidance provides an example of a reason for partial disallowance: “The amount of Employee Retention Credit (ERC) you claimed exceeds the maximum amount of qualified wages (including qualified health care expenses) you are entitled to claim per employee.” This means that the IRS calculated the amount of ERC it believed the taxpayer could claim, based on the number of employees reported on the applicable Form 941, and then compared that to the actual claim for a quarter. This determination by the IRS does not account for fluctuations in employee count during a quarter, which could be quite common in businesses that have high employee turnover. In addition, there may be other reasons why a taxpayer might appear to have claimed more credit than allowed; it’s important to carefully review the claim and the amount denied by the IRS, and to identify any other possible issues in the response. Again, taxpayers who have questions should consult their tax advisor to ensure they fully understand the IRS letter. This is important in order to effectively and efficiently respond to a full or partial disallowance.
The documentation requirements for responding to Letter 106-C are more focused on the calculation of ERC, rather than eligibility. Taxpayers responding to these letters should include documentation showing that the ERC claim did not exceed the limits per employee; details on how the ERC claim was calculated, including any worksheets used to compute the amount of ERC for each quarter (which may require payroll support) and a statement confirming your calculations did not include wages paid to related individuals or wages used to support Paycheck Protection Program loan forgiveness.
Additional documentation may be needed for large eligible employers, to prove that only qualified wages were included in the ERC calculation. Large employers could only claim ERC for wages paid to workers during time periods in which they were not performing services during the quarter at issue. As an example, if an employer paid an employee for the employee’s full scheduled time, but the employee was only allowed into the building for one four-hour shift per day because of governmental capacity or governmental social distancing restrictions, only the four hours for which the employee was paid but not working could be counted as qualified wages. Unlike the guidance for responding to Letters 105-C, the guidance for responding to Letters 106-C, partial disallowance, does not instruct taxpayers to provide an explanation and substantiation of their eligibility to claim ERC.
The new 105-C and 106-C guidance is clear that taxpayers have the right to appeal disallowances; however, IRS procedures do not allow Appeals to consider information that the IRS has not already reviewed. Therefore, responses will not go directly to Appeals for review. Instead, the IRS must first receive and review the taxpayer’s supporting information and documents. If the documentation and explanation submitted satisfies the IRS reviewer, the IRS can reverse its determination and allow the previously disallowed claim without sending the case to review by Appeals. Therefore, a matter should come before Appeals only after an IRS employee determines that the claim should still be disallowed.
Taxpayers should take care to submit all required documentation in the first response to a disallowance letter in order to avoid further delays in resolving a disallowed claim, because, as stated above, Appeals cannot review new documentation which has not already been reviewed by the IRS. Therefore, if a taxpayer were to get to Appeals and provide additional documentation at that stage of the process, Appeals should send the case back to the IRS for further review, which will cause additional delays in processing the taxpayer’s ERC claim.
After a taxpayer submits a response to a Letter 105-C or 106-C, they can expect a lengthy delay before hearing any response, according to the Taxpayer Advocate Service. As explained above, the IRS must first review any submissions prior to sending a case for Appeals to review. In addition, the IRS has likely received a large volume of protests in response to the tens of thousands of ERC disallowance letters issued in the last six or so months. Therefore, taxpayers can expect it will be months, if not years, before their disallowed ERC claims are resolved.
Taxpayers who submit a response to a Letter 105-C or Letter 106-C adjusting or disallowing their ERC claim must remain vigilant even after submitting their protest in order to ensure the period of limitations on refunds does not pass them by. Generally, taxpayers have two years from the date when the disallowance letter (either Letter 105-C or 106-C) was issued in which to file suit. While taxpayers can request review by Appeals through a written protest, this does not extend the two-year time limit. Under section 6514, the IRS is not permitted to issue a refund once this period of limitations on filing suit passes. Therefore, taxpayers must monitor this statute of limitations which begins to run on the date the IRS issued the disallowance letter.
If the end of the two-year period is approaching and the IRS has yet to make a decision on a taxpayer’s appeal (or if a favorable decision was made but the refund has not yet been paid), the taxpayer must choose between filing a claim for refund lawsuit or entering into an agreement with the IRS to extend the two-year period. If the two-year period of limitations ends without either of these actions happening, the IRS will be legally barred from issuing a refund, even if Appeals ultimately finds in the taxpayer’s favor regarding the claim.
Preparing and filing a lawsuit to can be an expensive and time-consuming process. The alternative, executing a Form 907, Agreement to Extend Time to Bring Suit, allows a taxpayer to come to an agreement with the IRS to extend the period of limitations on the time to file suit; however, this form must not only be filed, but also counter-signed by an authorized IRS official, before the two-year period of limitations expires. Identifying and contacting the appropriate individual at the IRS. to countersign may prove challenging before the case is assigned to an Appeals Officer. Therefore, taxpayers interested in pursuing a statute extension should plan to make the request well in advance, generally with the assistance of the Taxpayer Advocate Service. Taxpayers facing ERC disallowance letters should not delay their responses and should typically consult a tax advisor for assistance in preparing a response and navigating the administrative process.
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