Plastic Film, LLC v. United States, Civil No. 5:25-cv-30-DCB-LGI (S.D. Miss. June 22, 2026)

The Employee Retention Credit (ERC) has been one of the most heavily scrutinized tax provisions of the pandemic era. As the Internal Revenue Service (IRS) continues its sweeping compliance and enforcement efforts, a pivotal question has emerged in federal courts: what procedural avenues must the government use to recapture allegedly improper ERC refunds? In Plastic Film, LLC v. United States, the United States District Court for the Southern District of Mississippi addressed this critical issue, holding that the federal government is not restricted to administrative assessment procedures under 26 U.S.C. § 6205 when seeking to recapture improper ERC refunds. Instead, the court affirmed that the government retains its long-standing right to pursue civil recovery actions for erroneous refunds under 26 U.S.C. § 7405(b). At the same time, the court clarified that when the government asserts a civil recoupment counterclaim, it must meet federal plausibility pleading standards by alleging specific facts demonstrating ineligibility rather than merely relying on conclusory statutory recitations.

Case Background and Procedural History

The plaintiff, Plastic Film, LLC (Plastic Film), initiated this litigation on April 1, 2025, by filing a complaint against the United States of America and the United States Internal Revenue Service. The taxpayer asserted claims for: (1) a refund of payroll taxes under 26 U.S.C. § 7422(a); and (2) various violations of the Administrative Procedure Act (APA).

On January 20, 2026, the district 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 to the taxpayer for those periods. The court allowed Plastic Film’s refund claim for the third quarter of 2020 to proceed, but dismissed the APA claims for lack of standing, lack of waiver of sovereign immunity, and failure to state a claim.

Following the dismissal of the refund claims for the other quarters, the litigation shifted focus. On February 3, 2026, the government filed an Answer and Counterclaim under 26 U.S.C. §§ 7401 and 7405. Through this counterclaim, the government sought the judicial recapture of the allegedly erroneous ERC refunds that had been issued to Plastic Film for the second and fourth quarters of 2020 and the second quarter of 2021. In response, on March 16, 2026, Plastic Film filed a Motion for Judgment on the Pleadings as to the government's counterclaim under Federal Rule of Civil Procedure 12(c).

Taxpayer's Arguments and Request for Relief

In its Motion for Judgment on the Pleadings, Plastic Film advanced two primary arguments to defeat the government's recoupment efforts. First, the taxpayer argued that the Treasury Regulations promulgated in 2023 to address the recapture of erroneous pandemic-era employment tax credits—specifically 26 C.F.R. §§ 31.3111-6(b) and 31.3221-5(b)—compel the government to treat improper ERC refunds exclusively as underpayments of payroll taxes. Under this theory, the taxpayer contended that the IRS was required to recover these funds through the administrative assessment and collection process under 26 U.S.C. § 6205, thereby precluding a civil "erroneous refund" lawsuit under 26 U.S.C. § 7405.

Second, the taxpayer asserted that even if a civil action under Section 7405 were legally permissible, the government’s Counterclaim was factually deficient. Plastic Film argued that the pleading failed to meet federal plausibility standards because it simply "recites statutory language without alleging specific facts to show that any erroneous refund was made." Furthermore, Plastic Film pointed out that the government’s counterclaim incorrectly cited 26 U.S.C. § 3134(c)(2)(A)(ii)(I) to define an "eligible employer." Because Section 3134 governs only the third quarter of 2021—a quarter not at issue in the litigation—the taxpayer argued the government failed to plead a proper statutory basis for its claim.

Judicial Analysis of Section 7405 Civil Actions versus Administrative Assessment

The court first analyzed whether the IRS regulations issued in 2023 stripped the government of its authority to bring civil suits under 26 U.S.C. § 7405. Under 26 U.S.C. § 7405(b), Congress has explicitly authorized the United States to bring a civil action to recover any portion of a tax "which has been erroneously refunded." The court emphasized that this authority represents a well-established, independent remedy. Citing the landmark Supreme Court decision in United States v. Wurts, 303 U.S. 414 (1938), the court observed:

"The Government by appropriate action can recover funds which its agents have wrongfully, erroneously, or illegally paid."

Critically, the court noted that "no statute is necessary to authorize the government to sue in such a case, since the right to sue is independent of statute."

Plastic Film argued that because the 2023 regulations under 26 C.F.R. §§ 31.3111-6(b) and 31.3221-5(b) state that erroneous ERC refunds "shall be treated as an underpayment of the taxes... and may be assessed and collected by the Secretary in the same manner as the taxes," the use of the mandatory term "shall" mandated the exclusive use of the administrative underpayment process.

However, the district court rejected this restrictive interpretation by looking to the regulatory history and the preamble of the Final Rule. Published in the Federal Register, Vol. 88, No. 142, at page 48122 (July 26, 2023), the preamble explicitly stated that "[t]hese assessment and administrative collection procedures are not intended to be exclusive and therefore do not replace the existing recapture methods but rather represent an alternative method available to the IRS."

Rejecting the taxpayer's narrow reading, the court ruled:

"The plain language of the preamble indicates that the administrative assessment and collection procedures are alternatives, not replacements, for other statutory recapture methods available to the IRS, including the right to bring a civil action under § 7405."

The court further clarified that "The use of 'shall' in the regulation does not negate Congress's explicit grant of authority for the United States to recover erroneous refunds through suit." Consequently, the court held that "the United States may pursue recovery of erroneously refunded ERC amounts through a civil action under 26 U.S.C. § 7405."

The Plausibility Pleading Standard Applied to Government Counterclaims

While the government prevailed on the legal availability of Section 7405, it faced a severe setback regarding the factual sufficiency of its pleadings. The standard for a motion for judgment on the pleadings under Federal Rule of Civil Procedure 12(c) is identical to the standard for a motion to dismiss under Rule 12(b)(6), requiring that a pleading contain "sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face'" (quoting In re Great Lakes Dredge & Co., 624 F.3d 201, 210 (5th Cir. 2010), and Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). Facial plausibility is established when the pleading contains "factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged" (quoting Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)).

The court contrasted the factual detail in Plastic Film's original complaint with the threadbare nature of the government's counterclaim. In its complaint, Plastic Film sufficiently pleaded its Q3 2020 refund claim by providing "context and detail" regarding its business divisions (Food and Industrial), alleging they "together comprised more than half of its business in 2019." Plastic Film also alleged that "due to COVID-19 restrictions, it was compelled to suspend more than a nominal portion of its operations and experienced significant decreases in quarterly gross receipts in 2020 and 2021 compared to 2019."

By contrast, the government's counterclaim "merely asserts, without factual specificity, that Plastic Film was not eligible for the ERC in Q2 and Q4 2020 and Q2 2021." The court noted that "There are no additional facts pleaded explaining how Plastic Film failed to meet the eligibility requirements." Applying supreme pleading authorities, the court reiterated that under Iqbal:

"[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice."

The court concluded that the law of the case and the federal plausibility standard required the government to allege specific facts demonstrating ineligibility rather than merely reciting statutory elements.

Holding and Implications for Tax Practitioners

Addressing the government's statutory mis-citation, the court acknowledged the government's concession that the counterclaim incorrectly cited 26 U.S.C. § 3134(c)(2)(A)(ii)(I). Since the language in Section 3134 mirrors the CARES Act Section 2301(c)(2)(A) definition (as amended by Section 207 of the Relief Act), which does apply to the quarters at issue, the court exercised its discretion under Federal Rule of Civil Procedure 15(a)(2) to grant the government leave to amend its counterclaim. Relying on Fifth Circuit authority, the court noted that "leave to amend should be freely given when justice so requires, unless amendment would be futile" (citing United States ex rel. Marcy v. Rowan Cos., Inc., 520 F.3d 384, 392 (5th Cir. 2008)).

Ultimately, the court denied Plastic Film's Motion for Judgment on the Pleadings without prejudice and granted the government leave to amend its counterclaim within fourteen days. Specifically, the court ordered that "Defendants are granted leave to amend their Counterclaim... to correct the statutory citation and to plead sufficient factual content to meet the standards articulated in Iqbal and Twombly."

This ruling carries significant weight for CPAs, EAs, and tax controversy attorneys. It establishes that the IRS is not bound by its own 2023 administrative assessment regulations to recapture erroneous ERC refunds exclusively through underpayment assessments. Practitioners must be prepared for the government to initiate civil lawsuits under Section 7405 to claw back ERC refunds, even after the normal statute of limitations for administrative assessment has expired, subject to the separate limitations period in 26 U.S.C. § 6532. However, the case also provides a powerful defense for taxpayers: the government cannot simply file a boilerplate counterclaim alleging general ineligibility. The IRS must plead specific, non-conclusory facts detailing why the taxpayer fails to meet the ERC eligibility criteria, such as specific gross receipts figures or facts showing the business was not subject to a qualifying government suspension order.

Prepared with assistance from NotebookLM.