District Court Upholds Validity of IRS Guidance on Employee Retention Credit

(Parker Tax Publishing July 2025)

A district court held that the IRS did not violate the Administrative Procedure Act (APA) when it issued Notice 2021-20, which provides guidance on the employee retention credit in question-and-answer format. The court agreed with the government that the notice is merely an interpretive document rather than improper legislative rulemaking that should have been subject to the APA's notice-and-comment procedures. Stenson Tamaddon LLC v. IRS et al., 2025 PTC 221 (D. Ariz. 2025).

Background

Stenson Tamaddon LLC (StenTam) is a tax advisory firm that assists businesses with tax credits. StenTam helps businesses file employee retention credit (ERC) claims and is compensated from the proceeds of the credits refunded to its clients. It also defends claims that are challenged by the IRS, and if a claim is disallowed, StenTam does not receive compensation for its services on that submission.

The ERC is provided under Section 2301 of the CARES Act of 2020 (Pub. L. 116-136) and Code Sec. 3134. In March of 2021, the IRS published Notice 2021-20, a 102-page document in question-and-answer form that provide guidance on the ERC. According to StenTam, Notice 2021-20 "defined various terms in Section 3134, identified factors or elements necessary to claim the credit, set minimum thresholds for recovery of ERC, and imposed new, related record-keeping requirements - all of which resulted in the ERC being restricted to a lesser number of businesses than originally contemplated by Congress."

In May of 2024, StenTam filed a lawsuit asserting three causes of action under the Administrative Procedure Act (APA) with respect to Notice 2021-20: (1) violation of the APA's notice-and-comment rulemaking requirement; (2) arbitrary and capricious agency action in violation of the APA; and (3) unlawful agency action in excess of statutory authority in violation of the APA.

When an administrative agency issues a new rule, Section 553 of the APA generally requires that the agency publish a notice of proposed rulemaking in the Federal Register and allow interested persons an opportunity to comment on the proposed rulemaking. However, Section 553 exempts certain categories of agency action from the notice-and-comment requirements. The exemption at issue in this case allows agencies to issue "interpretive rules, general statements of policy, or rules of agency organization, procedure, or practice" without notice and comment.

The dispute in this case was thus whether Notice 2021-20 is a legislative (subject to notice and comment) or interpretive (exempted from notice-and-comment procedures) rule. In Hemp Indus. Ass'n v. DEA, 333 F.3d 1082 (9th Cir. 2023), the Ninth Circuit explained that interpretive rules "merely explain, but do not add to, the substantive law that already exists in the form of a statutory or legislative rule," whereas legislative rules "create rights, impose obligations, or effect a change in existing law pursuant to an authority delegated by Congress." Under the Ninth Circuit's framework, a rule has the force of law, and is therefore legislative, when: (1) in the absence of the rule, there would not be an "adequate legislative basis" for enforcement action, (2) the agency has explicitly invoked its general legislative authority, or (3) the rule effectively amends a prior legislative rule.

StenTam raised three primary arguments for why Notice 2021-20 was a legislative rule: (1) that it limited "eligible employers" under the statute by stating that household employers are not considered to operate a trade or business, and therefore are not eligible for the ERC with respect to their household employees; (2) that it narrowed the scope of suspensions caused by governmental orders that would qualify an employer for the ERC; and (3) that it imposed new recordkeeping requirements on employers.

Analysis

The court rejected StenTam's arguments and held that Notice 2021-20 is an interpretative, rather than a legislative rule that was not subject to notice and comment. In general, the court found that in issuing Notice 2021-20, the IRS did not appear to be making additions to the statute but simply trying to parse the precise meaning of the specific statutory language that Congress chose.

Regarding the exclusion of household employers from eligibility for the ERC, the court found that even in the absence of Notice 2021-20, there was an adequate legislative basis for the IRS to impose such a limit on eligible employers. In the court's view, the "carrying on a trade or business" language in the statute was not so vague that it failed to supply the necessary substance for the IRS to derive an interpretive, as opposed to a legislative rule. Rather, the court thought that there was a clear congressional edict contained within the statutory language and that in Notice 2021-20 the IRS was merely advising the public of its construction of that language.

The court also found that FAQ 10 of Notice 2021-20, which clarifies the part of the statute that limits eligible employers to those whose trade or business operations were "fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings" due to COVID-19, did not constitute a legislative rule. FAQ 10 interprets "orders from an appropriate governmental authority" as limited to either orders from the federal government or "from a State or local government that has jurisdiction over the employer's operations." This excludes "government orders that may have imposed substantial effects on an employer's stream of commerce, including customers in other jurisdictions." The court found that, while StenTam clearly disagreed with the IRS's interpretation, there was no reason to think that the statute - which narrowly points to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19 - failed to provide an adequate legislative basis for enforcement even in the absence of Notice 2021-20.

Finally, the court rejected StenTam's argument that the there was no legislative basis for the recordkeeping requirements set forth in FAQs 70 and 71 of Notice 2021-20. The court agreed with the government that these substantiation requirements track existing statutory and regulatory recordkeeping requirements that apply to taxpayers seeking employment-related refunds. Thus, FAQs 70 and 71 could not, in the court's view, be said to impose any new duty or right on taxpayers, or could they be said to lack an adequate legislative basis for enforcement. The court noted that even in the absence of FAQs 70 and 71, employers have an existing burden to prove their entitlement to the ERC. The court concluded that the FAQs merely clarify, but do not create, an existing and underlying statutory duty to maintain records proving an employer's entitlement to a tax credit by specifying the documents that would effectively prove the employer's entitlement to the ERC, specifically.

The court went on to find that the issuance of Notice 2021-20 was not arbitrary and capricious under the APA. The court reasoned that while StenTam would contend that the interpretations proffered in the Notice are not the best ones possible or better than the alternatives, its disagreement on these matters of policy did not render the IRS's interpretative determinations arbitrary and capricious. The court also rejected StenTam's assertion that the IRS lacked regulatory authority to issue Notice 2021-20 based on its earlier finding that the Notice is an interpretative, not legislative, rule.

For a discussion of the employee retention credit, see Parker Tax ¶106,460.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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