ERC Audit and Disallowance Defense for California Employers

The Employee Retention Credit is no longer a refund opportunity. It is an enforcement program. New claims are closed, the IRS audit window has been extended to six years, and disallowance letters that began arriving in early 2026 are landing on employers who filed in good faith years ago. If you received Letter 105-C, Letter 106-C, an examination notice, or a demand to repay a credit you already received and spent, the question now is defense — and there are deadlines that expire quietly.

At The Law Office of Pietro Canestrelli, we represent employers across Temecula, Murrieta, San Diego, Riverside, and San Bernardino in ERC examinations, appeals, and refund litigation. Pietro Canestrelli holds an LL.M. in Taxation and brings a working knowledge of how the federal tax system approaches these claims from the inside. Contact our office if you are holding an IRS notice about your credit.

Where the ERC Program Stands

The credit was enacted under the CARES Act to keep employees on payroll during pandemic disruption. It was legitimate, it was substantial — up to $26,000 per employee across eligible quarters — and it was aggressively marketed by promoters who often had no basis for the eligibility positions they were selling.

The IRS imposed a processing moratorium on September 14, 2023. Then the One Big Beautiful Bill Act, signed July 4, 2025, changed the landscape structurally:

• Section 70605(d) disallows Q3 and Q4 2021 claims filed after January 31, 2024. The IRS is barred from allowing or refunding them after July 4, 2025, regardless of whether the employer actually qualified. Claims postmarked on or before January 31, 2024 are unaffected.
• The assessment period is extended to six years — double the ordinary three — running from the latest of the original return filing, the deemed filing date, or the date the credit claim was made. An employer who received a refund in 2023 remains exposed well into the late 2020s.
• New penalties apply to promoters who failed due diligence standards, at $1,000 per failure.

The IRS reported closing most outstanding claims by the end of 2025. What remains is largely in examination, appeals, or litigation. If your refund has not arrived, it is generally because the claim is being scrutinized — not because it is waiting in a queue.

The Notices, and What Each One Means

Letter 105-C — Claim Disallowed

A full disallowance. This is the notice that starts the clock. You generally have two years from the date of the disallowance to resolve the claim or file a refund suit in district court or the Court of Federal Claims. Critically, filing an administrative appeal does not suspend that two-year period. Employers have lost otherwise viable claims by appealing, waiting, and letting the litigation deadline pass while the appeal sat unresolved.

In April 2026 the IRS added a streamlined option using Form 907 to extend the two-year window for taxpayers awaiting Independent Office of Appeals review with six months or less remaining. If you are approaching that point, this is time-sensitive.

Letter 106-C — Claim Partially Disallowed

Some quarters or some portion allowed, the rest denied. The same two-year rule applies to the disallowed portion.

OBBBA disallowance under Section 70605(d)

A statutory denial of a Q3 or Q4 2021 claim treated as filed after January 31, 2024. Appeal rights exist, but the productive argument is usually factual rather than legal: proving the claim was in fact timely submitted. Proof of mailing, certified mail receipts, transmission confirmations, even a dated shipping charge on a credit card statement can carry this. If you believe your claim was timely and was swept up in the statutory bar, that is a case worth building.

Examination notice

The IRS is auditing a credit already paid. This is where the six-year window matters and where documentation quality determines the outcome.

What the IRS Examines

ERC eligibility rested on one of two theories, and each fails in predictable ways.

Full or partial suspension of operations

The claim is that a governmental order suspended more than a nominal portion of the business. Examiners look for the specific order, its dates, and its actual effect on operations. Generic references to “COVID restrictions” do not carry it. What does: the text of the specific county or state health order, evidence of which operations it halted, and a quantification showing the suspended portion exceeded the nominal threshold.

California employers have a genuine advantage here that promoters often failed to develop. California’s orders were among the most restrictive and most specifically documented in the country, and Riverside, San Diego, and San Bernardino County health officers issued their own orders layered on top of state directives. A Temecula restaurant or a San Diego fitness facility frequently has a stronger documentary record than the boilerplate narrative filed on its behalf ever reflected.

Significant decline in gross receipts

A mechanical test comparing quarterly gross receipts to the same 2019 quarter. Common failure points: inconsistent definitions of gross receipts across quarters, failure to apply aggregation rules to commonly controlled entities, and using the wrong threshold for the wrong year.

Recurring documentation failures

• No copy of the actual governmental order relied on.
• Payroll records that do not tie to the Form 941-X figures.
• Wages double-counted against a PPP loan forgiveness application.
• Owner and related-party wages included when they should have been excluded.
• No supporting file at all, because the promoter kept it — or never built one.

What We Do

1. Establish the real deadline first. Before anything else, we identify the disallowance date, the two-year litigation window, and any assessment period issue. Everything else is scheduled around that.
2. Rebuild the eligibility file. Often the claim was defensible and the documentation simply was never assembled. Reconstructing the governmental order record and the operational impact is frequently the whole case.
3. Assess exposure honestly. If the claim does not hold, the analysis shifts to minimizing repayment, penalties, and interest — including whether a reasonable cause position exists based on reliance on a professional adviser.
4. Handle the examination or appeal. We deal with the revenue agent or appeals officer directly so the employer is not answering technical questions unprepared.
5. Preserve litigation as a real option. Refund suit is sometimes the correct path, and it stays available only if the deadline is protected.
6. Address the income tax side. Employers who reduced wage deductions for a credit later disallowed may be entitled to that deduction back. OBBBA extended the corresponding period so the refund claim is not stranded.

If repayment is unavoidable, collection alternatives are the next question — see our pages on offer in compromise, tax debt resolution, and liens, levies, and garnishments.

The California Layer

An ERC adjustment rarely stays federal. Disallowance changes the employer’s federal wage deduction, which flows to the California return and can generate its own Franchise Tax Board assessment. Where the underlying issue involves worker classification or payroll reporting, an EDD payroll tax audit can follow on a separate track with its own appeal path through the CUIAB. Handling the federal matter without accounting for the state consequences is a common and expensive oversight — and it is where a California tax attorney is worth more than a national ERC firm.

Frequently Asked Questions

Can I still file a new ERC claim?

No. The filing windows have closed, and OBBBA statutorily bars Q3 and Q4 2021 claims filed after January 31, 2024. Any service offering to file a new claim should be treated with considerable skepticism.

I got Letter 105-C. How long do I have?

Generally two years from the disallowance date to resolve the claim or file suit. An administrative appeal does not pause that clock. If you are within six months of the deadline and awaiting Appeals, a Form 907 extension may be available.

How far back can the IRS audit my ERC?

Six years, running from the latest of the original return filing, the deemed filing date, or the date the claim was made — extended from the ordinary three years by OBBBA.

My promoter filed the claim. Am I still liable?

Yes. The employer is responsible for the accuracy of its own return regardless of who prepared it. Reliance on a professional may support a penalty defense but does not eliminate the underlying liability.

Can I still withdraw a claim?

The formal withdrawal program is no longer generally available. Where a pending claim is not defensible, other correction paths may exist depending on posture — that assessment should be made before an examination opens, not after.

What if I already spent the refund?

That is common and it does not change the liability, but it does change the strategy. Collection alternatives including installment agreements and offers in compromise are evaluated alongside the merits defense.

Do Not Let the Deadline Decide the Outcome

The most damaging thing an employer can do with an ERC notice is set it aside. The two-year litigation window runs whether or not anyone is watching it, and once it closes a defensible claim becomes unrecoverable.

If you have received a disallowance letter, an examination notice, or a repayment demand, call our Temecula or San Diego office. We will identify your deadlines, evaluate whether the claim can be defended, and tell you candidly what your position is worth. Schedule a consultation, or learn more about our IRS audit defense and business tax audit representation.