A growing number of businesses in recent weeks are suing the payroll companies that filed their employee retention tax credit claims, alleging they’re not receiving some or all of their owed refunds.
For example, American Steel Inc. filed a proposed class action complaint in August against Vensure Employer Services Inc., an Arizona payroll company, alleging that Vensure didn’t pay the interest from the IRS owed to its clients.
The same month, Protect-US Inc., a California-based security guard business, filed a federal breach of contract complaint against Innoworks Employment Services Inc. The complaint alleged the payroll company withdrew Protect-US’s tax credit claim and isn’t responsive.
The disputes among payroll companies and taxpayers come as the IRS has ramped up enforcement on ERC claims that are suspected to be inaccurate. The ERC— created by Congress in 2020 as a tool to help businesses retain workers during the Covid-19 pandemic—is an ongoing headache for the IRS, which has said credit claims were riddled with fraud, causing delays in all processing.
The tax credit is projected to cost more than $300 billion—more than four times the Joint Committee on Taxation’s initial projected cost, according to a Sept. 10 analysis from Penn Wharton Budget Model.
Tax professionals said they’re seeing more audits into payroll companies and a wave of letters to businesses that the IRS suspects filed inaccurate claims. The IRS has sent 84,000 letters as of April either partially or fully disallowing ERC claims, according to the National Taxpayer Advocate.
Small businesses often use third-party professional employer organizations to outsource payroll and human resources, which filed the ERC claims on behalf of their clients. Because payroll companies are also liable for inaccurate claims, some are now reevaluating whether their clients qualify for the credit and are sometimes withholding refunds issued by the IRS, said Justin Elanjian, a Frost Law managing director who specializes in ERC claims.
“That is one of the biggest issues we’re observing that’s causing disputes,” said Elanjian, who has consulted on cases Frost Law has brought against payroll companies. “If that behavior continues, it’s probably reasonable to expect that the frequency of these disputes will increase.”
A Vensure spokesperson declined to comment on the lawsuit, citing company policy. Innoworks didn’t respond to a request for comment.
Feuds with Payroll Companies
Legal disputes between businesses and payroll companies have increased in the past few months, as the IRS has processed more ERC claims after a year-long moratorium, Elanjian said.
Some of the top issues businesses are raising include payroll companies withholding interest owed to them from the IRS or not filing the claim on time or at all, said Tracy Martinez, senior director of tax controversy at Omega Accounting Solutions.
“That’s happening a lot,” said Martinez, who has clients who have faced some of these issues. “Some of them aren’t even telling clients about the interest.”
Some of the frustration from taxpayers comes from a lack of communication from the payroll companies, said Peter Haukebo, a Frost Law partner who has worked with litigators representing clients in cases against payroll companies. Because the payroll companies filed for the tax credit, their customers can’t call the IRS for an update on the claims.
There are dozens of court cases around these issues, Haukebo said. Frost Law is representing Protect-US. Elanjian and Haubeko have consulted on the firm’s ERC cases.
“It’s a mess,” he said.
Who’s Liable
Payroll companies became more concerned with their liability for inaccurate claims after a February 2024 generic legal advice memorandum from the IRS that clarified payroll companies are “solely liable for underpayments resulting from improperly claimed credits.”That’s leading companies to hold up their clients’ refunds and examine whether the claims are legitimate in case they face an audit.
Martinez said companies shouldn’t be doing this. “The IRS has paid the claim, that should be the end of the discussion,” she said.
Elanjian agreed, saying payroll firms are “seemingly stepping into the seat of the IRS and calling the balls and strikes.”
Frost Law is also representing Elite Installations LLC, a Massachusetts contractor that’s suing Engage PEO. Elite Installations said in the Sept. 3 complaint that Engage received its ERC refund but the IRS held it for almost a year.
The National Association of Professional Employer Organizations in late August urged the IRS to rethink payroll companies’ liability.
“I urge you to quickly rescind this interpretation and clarify that liability belongs to the business that benefits from the claim,” NAPEO President and CEO Casey Clark said in the letter to Treasury Secretary Scott Bessent, who’s also acting IRS commissioner. “If not, thousands of small businesses could face financial hardship as tax credits they are lawfully entitled to are needlessly held up.”
Pressuring IRS to Finish Processing
Payroll companies are also pushing for the IRS to finish processing already filed ERC claims.
The IRS had over half a million ERC claims still not processed as of April, according to the National Taxpayer Advocate. And claims filed by payroll companies could include multiple businesses.
Vensure still has 1,000 claims not processed, said Chief Growth Officer Pat Cleary. The company started with 2,500 claims. The firm sent a delegation to speak with Congress members about the issue in late August, hoping lawmakers can pressure the IRS to finish processing.
“We’ve tried everything,” Cleary said. “There’s escalating levels of frustration from our clients.”
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