Our May 3, 2016 post discussed the importance of keeping business transactions separate from personal transactions so the corporate veil is not pierced. When we speak of the corporate veil, it not only applies to corporations, but also to limited liability companies (LLCs). Do you know that the IRS finds piercing the corporate veil of your corporation or LLC a relatively easy way to gain access to your personal assets (or vice-versa)?
The IRS collections and examination divisions pierce the corporate veil by availing themselves of the “alter ego doctrine”. The classification of a business entity as an alter ego of another entity, such as the business owner, can have significant adverse tax, legal and financial implications. While there is no federal statutory law or IRS regulations defining “alter ego”, it is a judicially recognized procedure or theory that has been established to address the potential injustice or alleged fraud actions that may occur in situations where individuals, persons and/or entities “mask” their ownership in equity and assets by placing them in the name and/or control of other persons or entities. While many in the legal profession would likely argue that the alter ego doctrine is governed by state law and not federal law, it is the published opinion of IRS Chief Counsel that federal common law governs.
Why would the IRS assert the alter ego doctrine? To get at assets that the IRS believes are owned by a related party. Let’s assume that the IRS Collections Division learns that an individual taxpayer (TP) has insufficient assets to pay his IRS debt, but that the TP exerts substantial control as an employee, director, or shareholder over a corporation (Corp). The IRS learns that the TP and Corp co-mingle corporate and personal finances and use corporate funds to pay personal expenses. There are also unsecured interest-free loans between TP and Corp. Corp is undercapitalized relative to its reasonable anticipated risks of business. In addition, Corp fails to maintain corporate minutes, follow its bylaws, hold an annual shareholder’s meeting, and makes no corporate resolutions relating to the payment of dividends. Do any of these items ring familiar to you and your business?
If so, you are running the risk of the IRS asserting the alter ego doctrine and placing a lien on the assets of Corp to satisfy your personal tax debts.
Too many business owners think of their personal and business assets as one and the same since they created the wealth for each. If you keep your business assets in one pocket of your trousers and your personal assets in another pocket, you will hopefully prevail against an IRS attempt to pierce the corporate veil. However, if you comingle the business and personal assets in one or more pockets of your trousers, you have enhanced the IRS’s ability to pierce the corporate veil using the alter ego doctrine.
If you want to discuss your business or personal tax planning and tax preparation concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.