I Health and Life Insurance Services v. United States, No. 25-1315T, United States Court of Federal Claims, July 23, 2026

For tax professionals advising clients on the Employee Retention Credit (ERC), the litigation landscape continues to evolve, establishing rigorous pleading and evidentiary standards. In I Health and Life Insurance Services v. United States, the United States Court of Federal Claims addressed the critical "suspension-of-business" prong under 26 U.S.C. § 3134(c)(2)(A)(ii)(I). The court's decision, authored by Judge Armando O. Bonilla, highlights the high bar taxpayers must clear to survive a motion for judgment on the pleadings under Rule 12(c) of the Rules of the United States Court of Federal Claims (RCFC). Specifically, the court held that a taxpayer must allege that government-mandated occupancy restrictions and worker exclusions caused a "discrete, more-than-nominal portion" of its active trade or business to temporarily cease. While finding that I Health failed to sufficiently plead a partial suspension, the court deferred ruling on the government's motion and granted the taxpayer leave to amend, recognizing the newly emerging precedents in the Circuit.

Procedural Posture and Facts of the Case

Founded in 2017, I Health and Life Insurance Services (I Health) is a life and health insurance sales agency based in California, with physical call centers operating in Fresno and San Diego counties. Prior to the COVID-19 pandemic, the agency's customer service representatives worked "in closequarters in open-air cubicles, and relied on location-specific technology tools and high-speed internet". Following California Governor Gavin C. Newsom's state of emergency declaration on March 4, 2020, and subsequent stay-at-home directives under Executive Order No. N-33-20, I Health transitioned into a highly disrupted operating environment.

Because I Health's business fell within the "Healthcare and Public Health Sector" critical infrastructure designation, it considered itself an essential business and continued operating its call centers. However, its physical operations were subjected to an array of stringent state and county regulations. To comply with these mandates, I Health implemented a series of preventive and protective measures, which included "comply[ing] with social distancing requirements" by increasing the distance between call center workstations and installing clear barriers; testing employees prior to their shifts and excluding those who tested positive or were exposed to COVID-19; transitioning a small portion of its workforce to remote work by providing "expensive and complex equipment"; and providing sanitization supplies and face masks. Furthermore, the company was required to grant supplemental paid sick leave to employees under the federal Emergency Paid Sick Leave Act and California Senate Bill 95.

I Health alleged that these state and county mandates "restricted [its] ability to maintain adequate staffing at its facilities," significantly "reduc[ed] its capacity," and "fundamentally altered [its] workspace," thereby causing a "partial suspension of [its] business operations".

The Taxpayer's Request for Relief and the Counterclaim

Seeking compensation for these business disruptions, I Health filed five Forms 941-X (Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund), asserting entitlement to the ERC under section 2301 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Pub. L. No. 116-136, 134 Stat. 281, 347–51 (2020) (codified as amended at 26 U.S.C. § 3134). The claims spanned multiple quarters, including the employment tax quarters ending June 30, 2020 (Q2 2020), September 30, 2020 (Q3 2020), December 31, 2020 (Q4 2020), March 31, 2021 (Q1 2021), and June 30, 2021 (Q2 2021).

Prior to and during the litigation, the Internal Revenue Service (IRS) issued overpayment notices for Q2 2020, Q4 2020, and Q1 2021. After the lawsuit was commenced on August 8, 2025, the IRS also issued an overpayment notice for Q2 2021, remitting a net tax refund of $392,010.40. Consequently, I Health filed an amended complaint on February 2, 2026, omitting its original Q2 2021 refund claim.

In response, the United States filed a counterclaim under 26 U.S.C. § 6532(b) seeking to recover the $392,010.40 Q2 2021 tax refund. The government also filed a motion for judgment on the pleadings pursuant to RCFC 12(c). This motion was narrow, targeting exclusively I Health's pending $50,000 tax refund claim for Q3 2020.

The Court's Analysis of the ERC Suspension Prong

To resolve the motion, the Court of Federal Claims applied the standard under RCFC 12(c), which is "substantially the same test as it does for a motion to dismiss for failure to state a claim under RCFC 12(b)(6)", citing Sikorsky Aircraft Corp. v. United States, 122 Fed. Cl. 711, 719 (2015). Under this standard, the court must "assume 'each well-pled factual allegation to be true and indulge in all reasonable inferences in favor of the nonmovant'" (quoting Owen v. United States, 851 F.2d 1404, 1407 (Fed. Cir. 1988)). However, legal conclusions framed as factual assertions are denied such deference, citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007).

The primary statutory question was whether I Health qualified as an "eligible employer" under 26 U.S.C. § 3134(c)(2)(A). Because there was no dispute that I Health was actively carrying on a trade or business, the inquiry focused on the "suspension-of-business prong" under 26 U.S.C. § 3134(c)(2)(A)(ii)(I). Drawing from its prior analysis in Northeast Health Services, LLC v. United States, ___ Fed. Cl. ___, No. 24-2096, 2026 WL 1530240 (May 28, 2026), the court outlined three cumulative requirements that a taxpayer must establish to claim the credit:

" that the business was ‘fully or partially suspended during the calendar quarter’; that there existed ‘orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to [COVID-19]’; and that the suspension of business was caused by (i.e., ‘due to’) a qualifying order."

If the taxpayer fails to satisfy even one of these prone requirements, it is ineligible for the credit.

Defining a Qualifying Government Order

Under the first step of its legal analysis, the court scrutinized the various state and local directives in effect during Q3 2020 (July 1 to September 30, 2020). Crucially, the court distinguished between mere "guidance" or "recommendations" and actual legal "orders". Citing Northeast Health, the court defined a qualifying government order as:

"...a government directive [that], as a whole, carr[ies] enforcement authority or otherwise ha[s] the ability to compel a certain course of conduct through the imposition of ‘binding requirements or repercussions for noncompliance.’" (quoting In re JSmith Civ., LLC, 674 B.R. 207, 214–15 (Bankr. E.D.N.C. 2025)).

Under this standard, several of the directives cited by I Health failed to qualify as orders:

Governor Newsom's Press Releases: The press releases dated May 7 and August 28, 2020, did not carry the force of law. The May 7 press release merely provided "guidance" without referencing enforcement mechanisms, and the August 28 release simply announced contemporaneous health officer actions.
Broad Statutory Generalities: The court rejected I Health's argument that all public health officer directives were backed by blanket criminal penalties under California Penal Code § 148(a)(1). The court noted that § 148(a)(1) "narrowly penalizes willful resistance to or obstruction of the enforcement of state and local directives; it does not punish mere noncompliance with those directives". Similarly, California Penal Code § 69 and Health and Safety Code § 120295 were found inapplicable as general enforcement mechanisms for every local public health recommendation.

Conversely, other directives successfully met the "order" standard:

Executive Orders: Executive Order Nos. N-25-20, N-33-20, and N-60-20 qualified as orders because they cited California Government Code § 8567(a), which explicitly mandates that the Governor's orders "shall have the force and effect of law".
State Public Health Reopening Directives: The May 7 and August 28, 2020 directives issued by the Acting State Public Health Officer qualified as orders because they cited California Health and Safety Code §§ 131080 and 120175, which grant broad, enforceable regulatory power over local authorities to control contagious diseases.
Countywide Health Officer Directives: Directives issued by the Fresno County and San Diego County health departments qualified as orders. They cited California Health and Safety Code § 120175 and explicitly stated on their face that "violation of th[e] order[s] [wa]s subject to fine, imprisonments or both".

The Strict Causation Standard for the Employee Retention Credit

Under the second prong of the statutory test, the court analyzed whether I Health's operational changes were proximately caused by ("due to") these qualifying governmental orders. To establish causation, a taxpayer must demonstrate that the qualifying order was "both the factual and proximate cause of a full or partial suspension", citing Northeast Health, 2026 WL 1530240, at *11.

In response to the government's motion, I Health narrowed its argument, conceding that its claim did not rest on "nominal" modifications such as mask mandates, sanitizing, or signage. Instead, I Health argued that its entitlement was rooted in the "order-mandated occupancy cap and worker exclusion".

The court agreed that, as a pleading matter, I Health sufficiently established causation. The relevant county directives used mandatory language, leaving "no room for discretion", citing Gilda Indus., Inc. v. United States, 622 F.3d 1358, 1364 (Fed. Cir. 2010). For example, the Fresno County orders mandated that employers "shall... screen all employees for febrile respiratory illness [and]... [e]xclude from work all employees that report symptoms". San Diego County's directives similarly mandated that essential businesses "shall... prohibit entry to the workplace of employees with a temperature of 100 degrees or more...". Furthermore, San Diego's "Business Safety Framework" "required" businesses to "develop a[n SRP]... [and] [e]stablish a reduced maximum occupancy".

The court rejected the government's argument that I Health would have excluded sick or exposed workers regardless of the government mandates. Judge Bonilla observed:

"Perhaps the government’s prediction is correct—and perhaps not. After all, I Health’s focus was presumably on staying in business and maintaining its bottom line during the pandemic-induced economic crisis, whereas the state and local governments’ primary concern was public health and safety."

Because these causation arguments represent factual disputes, they are "the proper subjects of discovery and trial" and do not entitle the government to judgment as a matter of law.

The Pleading Standard for a Full or Partial Suspension of Business

Despite clearing the hurdles of qualifying orders and causation, I Health's claim foundered on the final requirement: establishing that its business was actually "fully or partially suspended". Because the CARES Act does not define "full or partial suspension", the court engaged in statutory construction, guided by Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024). Under Loper Bright, while the court may look to the executive branch's interpretations to "inform [its] inquiry," it "may not delegate the task of statutory interpretation or otherwise defer to the relevant agency’s independent analysis".

Using the ordinary, dictionary definitions of "partial" and "suspension", the court concluded that the plain meaning of a "partial suspension" is a "cessation or discontinuance of part of the employer's business". However, to prevent the credit from offsetting insignificant costs, the court integrated the "nominal effect" standard found in IRS Notice 2021-20, which notes that a operational modification does not constitute a partial suspension unless it has "more than a nominal effect on the employer's business operations".

Adopting the standard articulated by Judge Kaplan in Sundancer Pools, Inc. v. United States, ___ Fed. Cl. ___, No. 25-1291, 2026 WL 1830419 (June 23, 2026), the court held:

"In short, the ordinary meaning of a ‘partial suspension’ of ‘the operation of [a] trade or business’ is a temporary interruption, postponement, or cessation of a more than nominal portion of a business’s operations."

To survive a motion for judgment on the pleadings, the taxpayer must plead that a "discrete, more-than-nominal portion of its business ceased". The court provided specific illustrations of factual scenarios that meet this partial-suspension standard:

Restaurants suspending in-person dining but continuing takeout and delivery services.
Retailers suspending on-premises shopping but continuing online sales.
Construction companies suspending in-office administrative operations but continuing onsite construction work.

Application of Law to the Taxpayer's Factual Allegations

In applying this legal framework to I Health's complaint, the court found the taxpayer's pleading deficient. I Health merely alleged that the occupancy caps and health-related employee exclusions forced a reduction in onsite capacity. Crucially, however, the call centers "continued operating throughout Q3 2020, albeit with unspecified reductions in onsite customer service representatives".

The court made clear that "a reduction in onsite capacity is not necessarily a cessation of a discrete, more-than-nominal portion of I Health’s operations". Because the business did not shut down any distinct segment of its service lines, and instead continued its core function of telephone sales and service through onsite and remote representatives, it failed to plead a "partial suspension" under the law. To state a claim, the taxpayer must allege that the government orders "caused it to temporarily cease performing a distinct portion of its business", quoting Sundancer Pools, 2026 WL 1830419, at *5.

Court's Deferral and Leave to Amend

Despite the pleading deficiencies, the court did not dismiss I Health's Q3 2020 refund claim. Instead, it invoked RCFC 15(a)(2), which instructs that the court "should freely give leave when justice so requires". Judge Bonilla deferred ruling on the government's motion and granted I Health leave to file a second amended complaint on or before August 6, 2026.

The court justified this procedural grace based on three critical factors:

First Impression Precedents: The pivotal opinions in Northeast Health and Sundancer Pools were issued after I Health had filed its amended complaint, leaving the taxpayer without the benefit of knowing the "requirements for ERC tax relief for the first time in this Circuit".
Procedural Consistency: Deferring judgment and allowing an opportunity to amend to cure identical pleading deficiencies was a mechanism previously "sanctioned by the Court in Sundancer Pools".
Prejudicial Impact on Counterclaims: The court astutely recognized that "a summary dismissal of I Health’s $50,000 ERC tax refund claim for Q3 2020 at this early stage might have an outsized influence on the government’s $400,000 ERC-based counterclaim for Q2 2021".

This decision underscores that while the Court of Federal Claims will enforce a rigorous and precise pleading standard for the ERC, it remains willing to afford taxpayers a fair opportunity to align their factual allegations with newly established judicial standards. Tax professionals must ensure that any pending or future ERC litigation complaints do not merely rely on general operational capacity reductions, but instead explicitly identify the discrete segment or operational division of the business that ceased to perform due to qualifying government orders.

Prepared with assistance from NotebookLM.