Navigating Employee Retention Credit rejections
Helping client understand IRS Letters 105C and 6577C
By Nick Pantaleo
January 24, 2025
The controversial Employee Retention Credit (ERC) has been a vital lifeline for many businesses during the COVID-19 pandemic, providing significant financial relief. Yet many other businesses in need have been waiting for years for their claims to be processed by the IRS.
With so many fraudulent claims filed during the early days of the program, it’s understandable the IRS would want to take its time to verify the legitimacy of the claims. The IRS developed risk criteria and additional tools to help identify ineligible claims or incorrect calculations.
Two common letters that businesses might receive are the
105C ERC rejection letter and the
6577C ERC partial rejection letter. Helping clients understand these letters and knowing how to respond can be crucial for securing the credits to which their business is entitled promptly.
IRS Letter 105C: Full rejection of ERC claim
IRS Letter 105C is a formal notification that the IRS has disallowed your client’s ERC claim. This letter indicates that the IRS has reviewed the claim and determined that it does not meet the eligibility criteria for the ERC. The 105C letter will typically include:
- The tax period in question.
- The amount of claim made.
- A generic statement about why the claim did not meet either a gross receipts drop or government mandate for the period in question.
- Information about your rights to appeal the decision.
The problem with the 105C letter is that it does not go into any details about how the IRS determined your client did not meet a drop in gross receipts or government mandate. The IRS can cross reference company gross receipts from a tax return, but it is not able to do so on a quarterly basis as the reference is an annual filing. This leaves it up to the taxpayer to appeal the letter with proof of qualification on a drop in gross receipts test.
For government mandates, the qualification for ERC comes from state and local mandates — as opposed to federally imposed mandates — in most cases. The IRS can approximate the time frame when different states were impacted. However, the ERC qualification is dependent upon a specific company’s operations and the extent to which it was individually impacted by any applicable state or local mandates. Thus, the 105C letter is being used as a method for requiring businesses to submit qualification criteria about questionable time periods when there weren’t many mandates in place. If you recall, that’s because such a qualification was not originally requested when submitting the 941-X to claim the ERC credit.
If you’re wondering if this approach is normal, it is not. However, the IRS has run out of options for stopping fraud and it needs to get these claims processed with the large backlog that has built up. As such, the IRS has laid out steps to appeal these decisions and has tried to accelerate the process for properly processing them.
It starts with filing an informal appeal that must be reviewed before it is elevated to a formal appeal decision, depending on the information provided. The IRS has explained in detail what is needed to initiate this appeals process.
Steps to take if you or your client receive Letter 105C
- Gather documentation. Collect all necessary documents that support your eligibility for the ERC, including payroll records for claiming the credit as well as financial statements and government orders as necessary.
- Respond to the IRS. If you disagree with the disallowance, you can respond to the IRS with the documentation to support your claim. It's crucial to do this within the timeframe specified in the letter, typically 30 days. Although you legally have more than the suggested 30 days to respond, it is best to do so quickly so you don’t impact the formal appeal process.
- Appeal the decision. If the IRS maintains its position after reviewing your additional documentation, you have the right to appeal the decision to the IRS Independent Office of Appeals. This appeal must be filed within two years of the date on the disallowance letter.
IRS Letter 6577C: Partial rejection of ERC claim
IRS Letter 6577C is issued when the IRS partially disallows a taxpayer’s ERC claim. This letter is usually received on claims the IRS has already paid.
NOTE: We have only seen this letter sent for claims paid for 2021 quarters. This means that while some portions of your client’s claim have been accepted as accurate, the IRS believes the amount it paid was incorrect. The 6577C letter will detail the specific calculation for the adjustment, but the most common reason we’ve seen for the 6577C being sent is that the IRS attempting to limit the ERC based upon the employee count from 941 line 1. This is where taxpayers indicate
“Number of employees who received wages, tips, or other compensation for the pay period including: Mar. 12, June 12, Sept. 12 or Dec 12.” The IRS takes this number, multiplies it by the $7,000 credit maximum for 2021 quarters and attempts to limit a taxpayer’s ERC claim to that notional cap.
This method can help identify excessive claims; however, it does not take into account any employees paid outside of that tax period. The ERC calculation is not limited in any way by this number. Instead, it’s based on the total number of employees paid throughout the quarter. This often causes taxpayers to receive 6577C letters in quarters when downsizing occurred or when they simply had fewer employees on staff at the time of the payroll. Further, companies with high turnover can end up paying two separate employees who filled the same position at different times during the same quarter. When that happens, per ERC rules, each employee would have their own individual $7,000 credit limit as the $7,000 credit limit is per person, not per role.
As a result of these factors, we’ve had a very high occurrence of 6577C letters for clients with small overclaims that can be simply defended by appealing the letter.
Steps to take if you or your client receive Letter 6577C
- Review the letter. Understand how much of your claim was disallowed and why.
- Correct errors. If the partial disallowance was due to calculation errors or incorrect information, correct these mistakes and gather supporting documentation.
- Submit additional documentation. Provide the IRS with any additional information or documentation that supports the portions of your client’s claim that were disallowed, including total employees paid and wages used for ERC for each individual.
- Appeal if necessary. Similar to the process for a full disallowance, you can appeal a partial disallowance if the IRS maintains a decision after initial documentation was submitted. Ensure you file the appeal for your client within the specified timeframe.
Avoiding panic — for you and your client!
Receiving an IRS disallowance letter can be daunting. But understanding the reasons behind the rejection and knowing how to respond can help you and your client navigate the process successfully. Whether your client receives a full rejection with Letter 105C or a partial rejection with Letter 6577C, taking prompt and informed action is essential to securing the credits your client’s business deserves. By following the steps outlined above and by maintaining thorough documentation, you can improve your chances of a favorable outcome.
Nick Pantaleo, CPA is Partner-CFO of Tri-Merit Specialty Tax Services
References
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Understanding Letter 105-C, Disallowance of the Employee Retention ...
