If, for example, you received a $100,000 employee retention credit (ERC) refund in 2026 for wages you paid in 2020 and 2021, you already know the IRS’s position: report the $100,000 as income on your 2026 return.

In our July article, we gave you a two-step strategy: follow the IRS guidance and report the income, then file a protective refund claim so you can get the tax back if the courts later reject the IRS’s position.

This article is about why the courts might do exactly that. The reason has a name: Twitchco.

Quick Refresher: What the IRS Wants

The law never allowed a double benefit.

When you claimed the ERC, you were required to reduce your 2020 and 2021 wage deductions by the amount of the credit—in those years.Many businesses didn’t, and by the time the refund checks arrived in 2026, the statute of limitations had closed for 2020 and 2021.

The IRS’s fix: under the “tax benefit rule,” include the ERC in income in the year you receive the check. The tax benefit rule says that when you deduct something in one year and a later event—here, the arrival of the credit— proves the deduction wrong, you pick up the income when the later event happens.

Sounds tidy. But there’s a hole in this logic, and a federal court drove a truck through that hole more than 50 years ago.

Meet Twitchco, Inc.

Twitchco, Inc., an Alabama company, “leased” three buildings from the City of Dothan and deducted the rent for years.

The IRS later determined the leases were really financing arrangements—Twitchco owned the buildings all along, so the rent deductions were improper from the start. But by the time the IRS figured this out, the statute of limitations for the early years had closed.

When Twitchco sold the buildings, the government tried the same move it’s trying with your ERC: use the tax benefit rule to pull the improperly deducted amounts into income in a year that’s still open.

The court said no.

The tax benefit rule applies only when the original deduction was proper. It does not let the IRS reach into a closed year, grab a deduction that was wrong when taken, and tax it in an open year.

And to the government’s complaint that the taxpayer would walk away with a double benefit, the court referred to the Supreme Court’s opinion: as statutes of limitations operate in tax law, sometimes the taxpayer gets advantages, while at other times the government gets them.

Why This Fits Your ERC Refund

Now map Twitchco onto your specific facts.

The moment you claimed the ERC on your Forms 941-X, the law required you to reduce your 2020 and 2021 wage deductions—in 2020 and 2021.5 You did not do so. That means your wage deductions were overstated—improper —in the wage years. That’s right: not in 2026, but in 2020 and 2021.

And here’s the part that should make the government squirm: your 941-X told the IRS about the overstatement.

The IRS had your claim in its hands while 2020 and 2021 were still wide open under the three-year statute of limitations.It could have adjusted the correct years. But the IRS processed nothing, sometimes for four or five years, and now wants the tax benefit rule to bail it out of its own delay.

That is the Twitchco fact pattern, almost line for line: an improper deduction in a closed year, full disclosure to the IRS, and a government that sat on its hands while the statute ran.

The Strongest Facts: You Hustled in 2021

Remember, if you took a PPP (Paycheck Protection Program) loan, you couldn’t claim the ERC at all until the December 27, 2020, law retroactively opened the door.

Suppose you moved fast and filed all your 941-Xs in December 2021. In that case, your speed pays off twice.

First, the IRS had the maximum runway—two and a half to nearly four years of open statute on your 2020 and 2021 income tax years—and still did nothing. 

Second, every year the government could plausibly call the “right” year for the income is now closed: the wage years (2020 and 2021) and the claim year (2021). Its only remaining theory is that the 2026 check is the taxable trigger—and that is precisely the theory Twitchco rejects when the deduction was improper in a closed year. 

Bonus point. If you filed your 2021 income tax return in 2022, after your 2020 941-Xs and your 2021 940s or 941- Xs, your 2021 wage deduction was improper on the day you signed the return. That’s the cleanest possible fit for the Twitchco rule.

Three Reasons Not to Get Cocky

First, Twitchco is one federal district court decision from 1972. It binds nobody outside that courtroom, although the Fifth Circuit affirmed the Tax Court decision it relied on.

Second, in 1983, the Supreme Court reframed the tax benefit rule around later events that are “fundamentally inconsistent” with the earlier deduction.9 The IRS built its ERC position on that framing, and the government will argue your deduction was proper when you filed and the 2026 check is the inconsistent event.

The fight will be over whether your deduction was “proper when taken” or “erroneous from the start”—which is why your 941-X and 941 filing dates matter so much.

Third, the courts are split. The Fifth Circuit blessed the erroneous-deduction exception; the Ninth Circuit rejected it. If you’re a West Coast taxpayer, you’re arguing against your home circuit’s precedent. Geography matters here.

The Fraud Gate: Clean Facts Only

Everything described above depends on one premise: that 2020 and 2021 are actually closed.

Fraud dissolves that premise. If your failure to reduce the wages was an intentional attempt to evade the tax, there is no statute of limitations—the IRS can assess the wage years directly, at any time, and can add the 75 percent civil fraud penalty.

And the same bad facts forfeit the Twitchco protection, which by its terms is unavailable to a taxpayer who misled the IRS.

The bar for fraud is high—the government must prove intent to evade, by clear and convincing evidence. Merely failing to amend, on its own, is not fraud.

A taxpayer who disclosed everything on a 941-X or a 941, waited out the IRS moratorium and mass disallowances, and reasonably wondered whether the check would ever come has innocent explanations to spare.

But if the file shows deliberate clock-running, the honest advice is the opposite of this article’s guidance. And note

that amending later does not cure fraud on the original return.

No Six-Year Rescue for the IRS

Technical point for tax pros. Question: Doesn’t the six-year statute for large omissions of income keep 2020 and 2021 open? Answer: No. The Supreme Court has held—twice—that an overstated deduction is not an “omission” from gross income. Absent fraud, three years means three years.

What to Do

For most taxpayers, our July 1 advice stands, and Twitchco upgrades it: report the ERC refund as 2026 income, pay the tax, and file a protective refund claim—but now your protective claim cites a specific legal theory.

The deduction was erroneous in a closed year; the IRS had open years and your 941-Xs or 941s in hand and failed to act; and under Twitchco and the Mayfair Minerals line of cases, the tax benefit rule does not apply. 

For the risk-tolerant taxpayer with the strongest facts, there is a more aggressive play. First, the strongest facts are

as follows:

• 941s filed on time and/or 941-Xs filed early and fully disclosed

• 21 return filed after the claim

• Squeaky-clean file

• No Ninth Circuit problem

The aggressive play: exclude the refund from 2026 income, and disclose the position on Form 8275.

The case law arguably gives you substantial authority, and disclosure should protect you from accuracy-related penalties even if you lose.16 But understand what you’re buying: a probable examination fight over a six-figure item, against an IRS position the government has billions of reasons to defend. 

Takeaways

The IRS wants your 2026 ERC refund included as income on your 2026 income tax return.

Twitchco says the tax benefit rule can’t reach a deduction that was improper in a closed year—and your wage deductions became improper in 2020 and 2021, the moment you claimed the credit.

The earlier you filed your 941-Xs (if needed), the stronger your case. The IRS had an open-statute runway it failed to use.

The authority exists, but it is thin. It all comes down to one district court decision, a favorable Fifth Circuit precedent, an unfavorable Ninth Circuit decision, and a Supreme Court case the government will almost certainly invoke. That mix is exactly what protective claims were made for: report, pay, protect, and let braver taxpayers make the case law.

Check your own file before you claim the high ground. Twitchco protects the taxpayer who was wrong in a closed

year. It does not protect the taxpayer who is lying.