Court allows counterclaim to recover ERC refunds
The government can file an erroneous refund suit under §7405 to recover Employee Retention Credit refunds. However, it must clearly state the facts that show why the taxpayer was not entitled to those refunds.
Holding
The U.S. District Court for the Southern District of Mississippi denied Plastic Film LLC’s request for judgment on the pleadings. The court decided that §7405 still lets the United States recover Employee Retention Credit refunds it claims were paid by mistake. The court also let the government revise its counterclaim because it had used the wrong statute and only made broad statements about ERC ineligibility without enough detail.
Why It Matters
The ruling preserves civil erroneous refund suits as an IRS recovery tool for ERC refunds. The 2023 ERC recapture regulations do not make administrative assessment the government’s exclusive remedy.
The decision matters for ERC litigation because refund suits can expose taxpayers to counterclaims for quarters in which the IRS has already paid ERC amounts.
The ruling does not decide whether Plastic Film qualified for the ERC. It only addresses the government’s authority to sue and the sufficiency of its pleading.
The pleading issue cuts both ways. The government can bring the counterclaim, but it must allege facts showing why the taxpayer failed ERC eligibility requirements. Bare statutory conclusions are not enough. Humanity survives another day because Rule 8 still requires facts.
Key Facts
Plastic Film LLC sued the United States and the IRS on April 1, 2025.
The complaint asserted:
A payroll tax refund claim under §7422(a).
Administrative Procedure Act claims.
The dispute involved ERC claims for multiple calendar quarters.
On January 20, 2026, the Court dismissed as moot Plastic Film’s refund claims for the second and fourth quarters of 2020 and the second quarter of 2021 because the IRS had already issued refunds for those periods.
The Court allowed Plastic Film’s refund claim for the third quarter of 2020 to proceed.
The Court dismissed the APA claims for lack of standing, lack of waiver of sovereign immunity, and failure to state a claim.
On February 3, 2026, the government filed an answer and counterclaim. It sought recovery of alleged erroneous tax refunds under §§7401 and 7405.
Plastic Film moved for judgment on the pleadings against the counterclaim.
Plastic Film argued that improper ERC refunds must be treated as payroll tax underpayments and recovered through administrative procedures under §6205.
Plastic Film also argued that the counterclaim failed federal pleading standards because it recited statutory language without alleging facts showing that the refunds were erroneous.
The government responded that §7405 authorized a civil action to recover erroneous ERC refunds and that the 2023 ERC recapture regulations did not eliminate that remedy.
Statutory or Regulatory Framework
Section 7405(b) authorizes the United States to bring a civil action to recover any portion of a tax that has been erroneously refunded.
Section 7401 authorizes civil actions by the United States to recover taxes, subject to authorization requirements.
Section 6532 generally supplies the limitations period for erroneous refund suits.
Section 6205 allows administrative correction of certain employment tax underpayments.
The ERC, or Employee Retention Credit, is a refundable payroll tax credit enacted during the COVID-19 period for eligible employers that met specified suspension or gross receipts tests.
The 2023 ERC recapture regulations treat some erroneous ERC refunds as underpayments of employment taxes that may be assessed and collected administratively.
Arguments
Taxpayer argued:
The ERC recapture regulations required improper ERC refunds to be treated as underpayments of payroll taxes.
The government had to use the administrative assessment process under §6205.
Section 7405 did not apply because the regulations supplied the required recovery method.
The regulation’s use of “shall” made the administrative method mandatory.
The government’s counterclaim failed because it did not allege specific facts showing that Plastic Film was ineligible for the ERC.
The counterclaim relied on conclusory assertions rather than factual allegations that satisfied Twombly and Iqbal.
Government argued:
Section 7405 expressly allows the United States to sue to recover erroneous refunds.
The 2023 ERC recapture regulations did not repeal or limit §7405.
The regulatory preamble stated that assessment and administrative collection procedures were not exclusive.
Administrative recapture is an additional method, not a replacement for civil erroneous refund suits.
The counterclaim plausibly alleged that Plastic Film was not entitled to the refunds.
The government should be granted leave to amend if the Court finds the statutory citation incorrect or the pleading deficient.
Court’s Reasoning
Section 7405(b) expressly authorizes the United States to sue to recover erroneously refunded taxes.
Longstanding Supreme Court precedent recognizes the government’s right to recover money wrongfully or erroneously paid.
The 2023 ERC recapture regulations did not eliminate the government’s statutory authority under §7405.
The regulatory preamble stated that administrative assessment and collection procedures were not exclusive to, nor did they replace, existing recapture methods.
The regulation’s use of “shall” did not override Congress’s express grant of authority under §7405.
The government therefore may pursue recovery of allegedly erroneous ERC refunds through a civil action.
The government’s counterclaim still had pleading defects. It cited §3134, which applies to ERC claims for the third quarter of 2021, even though the relevant quarters were earlier.
The government also alleged Plastic Film’s ineligibility for ERC without sufficient factual detail.
The Court compared the counterclaim with Plastic Film’s refund pleading. Plastic Film had alleged business divisions, COVID-19 restrictions, operational suspensions, and gross-receipt declines. The government’s counterclaim did not provide comparable factual content.
The Court granted leave to amend because correcting the citation and adding factual allegations could cure the defects.
Result
The Court denied Plastic Film’s request for judgment on the pleadings, but without prejudice, and gave the government 14 days to revise its counterclaim.
The Takeaway
ERC refund lawsuits can create risks for both sides. If a taxpayer sues for more ERC money, the government may respond with a counterclaim to get back refunds it already paid.
This ruling matters more for choosing the right legal remedy than for deciding ERC eligibility. It confirms the IRS can use both civil lawsuits and administrative ERC recapture, but still requires strong factual claims.
List of Citations
CARES Act §2301(c)(2)(A): Supplies the relevant ERC eligible employer definition for earlier ERC quarters.
26 C.F.R. §31.3111-6(b): Addresses ERC recapture for certain employment tax credits.
26 C.F.R. §31.3221-5(b): Addresses ERC recapture in the railroad employment tax context.
United States v. Wurts, 303 U.S. 414 (1938): Recognizes the government’s authority to recover funds erroneously or illegally paid.
Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007): Requires factual allegations sufficient to make a claim plausible.
Ashcroft v. Iqbal, 556 U.S. 662 (2009): Rejects threadbare legal conclusions as insufficient pleading.
In re Great Lakes Dredge & Dock Co., 624 F.3d 201 (5th Cir. 2010): Applies the Rule 12(b)(6) plausibility standard to Rule 12(c) motions.
Doe v. MySpace, Inc., 528 F.3d 413 (5th Cir. 2008): Addresses the standard for judgment on the pleadings.
United States ex rel. Marcy v. Rowan Cos., Inc., 520 F.3d 384 (5th Cir. 2008): Supports liberal leave to amend when amendment is not futile.