Background
Sundancer Pools, Inc., a Southern California-based residential and commercial pool construction company, filed claims for the Employee Retention Credit (ERC) under the CARES Act for six quarters spanning Q2 2020 through Q3 2021. The IRS approved Sundancer’s ERC claims for the first four quarters but disallowed the credit for Q2 and Q3 2021, denying a claimed refund of $660,292.61 plus interest. Sundancer sued in the Court of Federal Claims seeking recovery of that amount.
The ERC is a refundable tax credit available to employers whose operations were “fully or partially suspended” due to government orders limiting commerce, travel, or group meetings because of COVID-19, or who experienced specified declines in gross receipts. Sundancer’s complaint detailed various government directives it claimed impacted its operations, including social distancing requirements, permit processing delays, supply chain disruptions, and material shortages.
The government moved for judgment on the pleadings, contending that even accepting all of Sundancer’s allegations as true, the complaint failed to allege facts showing a full or partial suspension of operations or that any suspension resulted from a qualifying government order.
The Court’s Holding
The Court granted the government’s motion, holding that Sundancer’s complaint did not state a plausible claim for relief. The court interpreted “fully or partially suspended” to mean a temporary interruption, postponement, or cessation of a more than nominal portion of a business’s operations—not merely operational modifications or efficiency losses. The court rejected Sundancer’s argument that genuine issues of material fact required denial of the motion, clarifying that a defendant’s motion for judgment on the pleadings uses the same standard as a motion to dismiss: accepting all allegations as true, the court determines whether they suffice to support a legal claim.
Critically, the court held that the phrase “due to” in the statute requires both factual (but-for) causation and proximate causation—the government order must have been both a necessary and foreseeable cause of the suspension. This standard prevents employers from claiming ERC eligibility merely because pandemic-related supply chain disruptions, material shortages, or economic conditions affected their profitability. The court found Sundancer’s allegations showed operational adjustments and reduced efficiency due to social distancing, permit delays, and supply shortages, but not actual cessation of business operations proximately caused by government orders. The court deferred final ruling and gave Sundancer leave to amend its complaint by July 23, 2026.
Key Takeaways
- A business must demonstrate actual temporary cessation or interruption of operations—not merely operational modifications, efficiency losses, or profit reductions—to qualify for the ERC under the suspension-of-operations prong.
- The causal nexus between a government order and business suspension requires proximate causation, not just but-for causation, preventing claims based on indirect pandemic effects like supply chain disruptions unmoored to specific orders.
- General compliance costs and workarounds that keep a business operating do not establish a suspension, even if COVID-19 protocols required resource reallocation or increased expenses.
- IRS Notice 2021-20 guidance stating that a partial suspension involves closure of operations representing more than 10 percent of gross receipts or labor hours constitutes persuasive agency interpretation under the Skidmore standard.
Why It Matters
This decision provides critical guidance narrowing ERC eligibility for businesses nationwide and establishes a rigorous causality standard that will be binding on the Court of Federal Claims and influential in federal litigation. By requiring proximate causation and rejecting operational-difficulty theories, the court prevents what it characterizes as an overly permissive interpretation that would allow most pandemic-affected businesses to claim the credit, thereby rendering the alternative “decline in gross receipts” eligibility test superfluous. This holding reflects judicial concern about statutory interpretation that would collapse distinct eligibility pathways into one.
The decision will significantly affect pending and future ERC litigation, particularly for businesses in industries that modified operations but never ceased performing core functions. It raises the evidentiary bar for employers seeking refunds and signals courts’ willingness to impose demanding factual pleading requirements at the motion-to-dismiss stage, potentially limiting discovery rights before amendment opportunities are exhausted. For businesses relying on supply chain disruptions or efficiency losses as the basis for ERC claims, this opinion suggests the need for more specific factual allegations demonstrating actual operational cessation rather than operational constraints.