A recent decision from the United States District Court for the District of Arizona in Stenson Tamaddon LLC v. United States Internal Revenue Service, et al. (Case No. CV-24-01123-PHX-SPL) provides critical insights for tax practitioners regarding the Internal Revenue Service’s (IRS) guidance on the Employee Retention Credit (ERC) program. This case addresses a multifaceted challenge to the IRS’s "Notice 2021-20," a 102-page question-and-answer document providing guidance on the ERC. The plaintiff, Stenson Tamaddon LLC (StenTam), a tax advisory firm specializing in ERC claims, contended that this Notice constituted improper legislative rulemaking, bypassing the Administrative Procedure Act’s (APA) notice-and-comment requirements, and was arbitrary, capricious, or beyond the IRS’s statutory authority. The Court, in its ruling on cross-motions for summary judgment, ultimately sided with the government, affirming the IRS’s authority to issue such interpretive guidance without formal rulemaking procedures.

Factual Background

The Employee Retention Credit (ERC) Program: The ERC was established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020, with the goal of stimulating economic recovery, supporting job retention, and aiding businesses affected by COVID-19. It provides a refundable tax credit to employers who paid qualified wages despite being adversely affected by the pandemic. Initially available for wages paid between March 12, 2020, and January 1, 2021, the ERC was later extended to qualified wages for 2021 calendar quarters. However, the subsequent Infrastructure Investment and Jobs Act retroactively terminated the ERC for most employers, making it unavailable in the fourth quarter of 2021, except for recovery startup businesses. The credit amount was also increased by Congress from 50% to 70% of qualified wages for 2021 quarters.

Employer Eligibility for ERC: Employers could qualify as "eligible employers" if they met certain criteria:

Carrying on a trade or business during the calendar quarter.
The operation of the trade or business was fully or partially suspended during the quarter due to governmental orders limiting commerce, travel, or group meetings due to COVID-19.
The employer’s gross receipts for the calendar quarter were less than 80% of the gross receipts for the same calendar quarter in 2019.
The employer was a recovery startup business.

IRS Guidance and Dispute: The CARES Act authorized the Secretary of the Treasury to "issue forms, instructions, regulations, and guidance as are necessary" to facilitate the ERC program. However, it did not explicitly exempt the IRS from the APA’s notice-and-comment rulemaking process. In March 2021, the IRS published "Notice 2021-20," a comprehensive document in a "question and answer" format, designed to provide guidance on the ERC.

StenTam argued that this Notice improperly "defined various terms," "identified factors or elements necessary to claim the credit," "set minimum thresholds for recovery of ERC," and "imposed new, related record-keeping requirements". StenTam contended that these actions restricted the ERC to fewer businesses than Congress intended, thereby creating substantive duties and restrictions with the force of law that should have been subject to APA notice-and-comment procedures. The core dispute revolved around whether Notice 2021-20 was merely an interpretive document or an improper legislative rule.

Plaintiff Stenson Tamaddon LLC: StenTam is a tax advisory and technology firm that assists businesses with tax credits and financial solutions, particularly with filing ERC claims. Its compensation is derived from the proceeds of credits refunded to its clients, and it receives no compensation if a claim is disallowed. StenTam asserted that it dedicates significant resources to complying with IRS policy positions on the ERC and must adjust its business practices accordingly, incurring considerable costs. Thus, StenTam claimed direct injury from IRS positions that "unlawfully narrow or limit the availability of ERC for businesses".

Taxpayer’s Request for Relief

StenTam initiated the action on May 14, 2024, asserting five causes of action against the United States, the IRS, the Department of Treasury, and their respective Commissioners (construed by the Court as an action against the United States). The claims included:

Violation of the APA’s notice-and-comment rulemaking requirement.
Arbitrary and capricious agency action in violation of the APA.
Unlawful agency action in excess of statutory authority in violation of the APA.
Ultra vires action in violation of the APA.
A claim for writ of mandamus against Defendants Yellen and Werfel.

StenTam initially sought a preliminary injunction on Counts IV and V to enjoin the IRS’s moratorium on ERC claim processing, which the Court denied, although it found StenTam had Article III standing for those claims. Subsequently, Counts IV and V were dismissed by stipulation after the IRS lifted its moratorium. Consequently, the cross-motions for summary judgment focused solely on the APA claims in Counts I, II, and III.

Court’s Analysis of the Law and Application to Facts

The Court’s analysis focused on four main topics: standing, sovereign immunity, the classification of Notice 2021-20 as a legislative or interpretive rule, and whether the Notice was arbitrary and capricious or beyond statutory authority.

Standing

The Government argued StenTam lacked standing to challenge Notice 2021-20. Standing requires: (1) an injury in fact, (2) traceability to the defendant’s conduct, and (3) redressability by a favorable judicial decision.

Constitutional Standing: The Government disputed traceability and redressability, arguing any injury flowed from the statute itself, not the Notice, because the Notice "itself does not require StenTam or its clients to do anything or prevent them from doing anything".
- The Court’s Finding: The Court found StenTam had demonstrated an injury-in-fact because the Notice was used to deny ERC claims for StenTam clients, leading to a loss of funds. Critically, the Court determined that the Government’s standing argument was "inextricably intertwined" with the merits. If the Notice carried the force of law, then the denial of claims would flow from the IRS’s binding interpretation in the Notice, making the injury traceable and redressable by vacating the Notice. The Court concluded that StenTam demonstrated its economic injuries were causally linked to the IRS’s alleged misconduct, and that failing on the merits would not defeat standing.
Prudential Standing: The Government argued StenTam’s alleged injury was not "within the zone of interests to be protected or regulated by the ERC statute".
- The Court’s Finding: The Court rejected this argument, reiterating its prior finding that the CARES Act intentionally created the ERC program for the benefit of plaintiff’s clients, and "professional tax preparation services are essential in carrying out Congress’ intent with respect to these clients". Therefore, StenTam had prudential standing.

Sovereign Immunity

The Government argued that even with standing, the Court lacked jurisdiction due to sovereign immunity, asserting an adequate alternative statutory remedy exists through tax refund suits under I.R.C. § 7422.

The Court’s Finding: The Court previously rejected this argument, noting that while taxpayers (StenTam’s clients) might have a refund suit remedy, "this is incorrect for third parties who may be affected by Defendant IRS’s handling of the ERC program". StenTam itself was not pursuing tax remedies but challenging the IRS’s alleged improper rulemaking under the APA, making the APA the appropriate avenue for relief. The Notice was considered a "final agency action for which there is no other adequate remedy in a court". Thus, the sovereign immunity argument failed.

Legislative Rulemaking or Interpretive Rule

This was the central dispute. Legislative rules require notice-and-comment procedures under APA Section 553, while interpretive rules are exempt. Interpretive rules generally "do not have the force and effect of law" and "merely explain, but do not add to, the substantive law that already exists". Legislative rules "create rights, impose obligations, or effect a change in existing law". An agency action is "not in accordance with law" if it is a legislative rule masquerading as an interpretive rule.

The Ninth Circuit’s Hemp framework, derived from American Mining Congress, identifies three factors for determining if a rule has the force of law (and is thus legislative):

In the absence of the rule, there would not be an adequate legislative basis for enforcement action.
The agency has explicitly invoked its general legislative authority.
The rule effectively amends a prior legislative rule.

1. Adequate Legislative Basis: StenTam challenged three main aspects of Notice 2021-20:
- Limiting Eligible Employers (Household Employers): FAQ 6 stated that "Household employers are not considered to operate a trade or business and, therefore, are not eligible for the employee retention credit with respect to their household employees".
  - The Court’s Finding: The Court found this to be an interpretation of the existing statutory language requiring an employer to be "carrying on a trade or business". The statute’s language provided an adequate legislative basis, meaning the IRS was merely "advising the public of its construction of that statutory language," not creating new law.
- Governmental Orders and Partial Suspension:
  - "Appropriate Governmental Authority": FAQ 10 limited "orders from an appropriate governmental authority" to federal, state, or local government orders with jurisdiction over the employer’s operations. StenTam argued this unduly limited eligibility.
    - The Court’s Finding: The Court found this a "natural interpretation of the plain meaning of the statutory text," noting that Congress could have used broader language but did not. The statute provided an adequate legislative basis.
  - "Partially Suspended" (Nominal Portion Standard): FAQ 11 introduced a "nominal portion" standard, deeming operations suspended if "more than a nominal portion of its business operations are suspended by a governmental order". It defined "nominal portion" as 10% of gross receipts or employee hours. StenTam called this a "novel standard".
    - The Court’s Finding: The Court agreed with the Government that the 10% provision was a "safe harbor," meaning the IRS would "deem that employer eligible" if the impact met this threshold, while still allowing for "facts and circumstances" eligibility determination for impacts below 10%. The Court found StenTam’s addition of "only" to the IRS’s text misrepresented its intent. While acknowledging concern about policy statements being applied as binding rules, the Court noted that consistent application of policy is expected and does not automatically convert it to a legislative rule, as long as agency discretion is retained. The Court distinguished Hoctor v. USDA, where a numerical rule was deemed arbitrary, by emphasizing that the 10% rule in Notice 2021-20 was a rebuttable presumption or safe harbor, not an absolute cutoff.
  - Voluntary Suspension/Comparable Operations: FAQs 14-16 clarified that voluntary suspensions or choosing not to operate in a modified manner (when capable) would not qualify as a suspension due to governmental order.
    - The Court’s Finding: The Court found these to be "obvious and natural interpretation[s]" and "natural extension[s]" of the statutory language, which specifies suspension due to governmental authority, not voluntary actions.
- Recordkeeping Requirements: FAQs 70 and 71 required employers to substantiate eligibility and keep employment tax records for at least four years. StenTam argued there was no legislative basis for these.
  - The Court’s Finding: The Court found these requirements derived from existing Internal Revenue Code Section 6001 and its implementing Treasury Regulations (26 C.F.R. § 31.6001-1), which impose general recordkeeping obligations on taxpayers seeking employment-related refunds. Thus, the Notice merely "reiterates the statutory requirement" and clarifies which specific documents would prove ERC entitlement, rather than imposing new duties.
- Overall Conclusion on Adequate Legislative Basis: The Court concluded that the IRS was interpreting, not modifying or supplementing, the ERC statute. Congress cannot anticipate every hypothetical, and agencies have expertise to issue interpretive guidance. The Court acknowledged the "practical binding effect" of the Notice but stressed that this is not equivalent to a "legally binding effect".
2. Invoking General Legislative Authority:
- The Court’s Finding: The IRS did not invoke its general legislative authority in issuing the Notice; instead, it consistently referred to the information as "guidance". This factor weighed against finding it a legislative rule.
3. Effectively Amending a Prior Legislative Rule:
- The Court’s Finding: StenTam argued the Notice "effectively amending" the ERC statute itself. The Court rejected this, stating that an interpretive rule supplying "crisper and more detailed lines" does not become an amendment simply because it refines vague statutory language. This aligns with the finding that there was an adequate legislative basis and the Notice was interpretive.

Arbitrary/Capricious Agency Action

Even if interpretive, a rule can be struck down if it is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law" under APA Section 706(2)(A). This review is narrow and deferential; the Court cannot substitute its policy judgment for the agency’s. An action is arbitrary and capricious if the agency: (1) relied on factors Congress did not intend, (2) entirely failed to consider an important aspect of the problem, or (3) offered an explanation that runs counter to evidence or is implausible.

Distinguishing CIC Services, LLC v. IRS: StenTam compared its case to CIC Services, where an IRS notice was struck down as arbitrary and capricious for lacking factual support for its designation of certain transactions as reportable.
- The Court’s Finding: The Court distinguished CIC Services, noting that here, the Notice interpreted an "organic statute itself," not a regulation, and involved policy determinations, not factual ones requiring specific data. The IRS was interpreting statutory terms, and no facts or data were required for that analysis. The Court cannot deem policy disagreements as arbitrary and capricious.
Application to Notice 2021-20:
- Factors Not Intended/Implausible Explanations: The Court found the IRS’s interpretations could be ascribed to a "difference in view" rather than running "counter to the evidence" (as there was no factual evidence beyond the statute’s text) or relying on "factors Congress did not intend".
- Failure to Consider Important Aspects: StenTam argued the IRS failed to explain certain distinctions (e.g., reduction in hours vs. reduction in resources/customers).
  - The Court’s Finding: This argument was "belied by the administrative record," as the IRS had received and circulated "multiple inquiry letters" on these very issues. Regarding the 10% "nominal portion" test, the Court reiterated it was a safe harbor, not an arbitrary exclusionary cutoff.

Beyond Statutory Authority

StenTam’s final claim was that the IRS acted beyond its statutory authority.

The Court’s Finding: This claim largely depended on the Notice being a legislative rule, which the Court had already rejected. The Court found the IRS’s interpretation did not "depart from or change the statutory text". Furthermore, the Court noted that the "major questions doctrine" and the Supreme Court’s Loper Bright decision were irrelevant because the Notice "carries no force of law and is entitled to no deference". This claim also failed.

Conclusion

The Court ultimately denied Stenson Tamaddon LLC’s Motion for Summary Judgment and granted the United States of America’s Cross Motion for Summary Judgment, terminating the action.

The Court acknowledged the inherent difficulty in distinguishing between legislative and interpretive rules, especially given the "practical effect" interpretive guidance can have. However, it emphasized that a practical binding effect is not legally binding. The Court concluded that the IRS was under pressure to issue timely guidance for the swiftly passed ERC program and that issuing it as an interpretive FAQ, rather than undergoing lengthy notice-and-comment procedures, was a permissible exercise of agency discretion. It stressed that agencies must be able to interpret statutes in a meaningful way beyond mere paraphrasing, supplying "crisper and more detailed lines" to aid public understanding, which Congress intended by including an interpretive rule exception in the APA. The Court concluded that StenTam’s disagreement with the IRS’s interpretations in Notice 2021-20 did not render them legislative, arbitrary and capricious, or beyond statutory authority.

This decision serves as a significant reminder that while IRS guidance, even in FAQ format, can have substantial practical implications for taxpayers and tax professionals, the courts may still uphold it as a valid interpretive rule that does not require formal notice-and-comment rulemaking, provided it genuinely interprets existing statutory language rather than creating new law. Tax practitioners should carefully review the specific statutory text underlying any IRS guidance to assess whether it represents a new obligation or merely a reasonable interpretation.

Prepared with assistance from NotebookLM.