IRS to use alter ego doctrine to collect taxes from business

When the IRS uses the alter ego theory to collect debts from company owners, this is referred to as “piercing the corporate veil.” If the IRS believes that assets have been moved to the firm to escape the owner’s tax responsibilities, it may seek to demonstrate that a corporate or limited liability partnership (Lp) is now the alter ego of an individual’s income who owns shares or even all of the business.

What is alter ego doctrine?

It is a widely held belief that a corporation is a separate entity from its directors and shareholders. This common law concept protects stakeholders and executives from being held accountable for the corporation’s debts and criminal responsibilities. However, the notion of alter ego provides a legal exception to this assumption. Alter ego is the theory that forbids the corporation’s stakeholders, i.e., shareholders and directors, from relying on the doctrine of a distinct legal entity. As a result, the alter ego doctrine is predicated on removing the veil of incorporation between the directors/shareholders and the company and considering them as one entity.

As a result, when the shareholders/directors and the company or a LLC have a very clear boundary of distinction, the court system can rely on the alter ego doctrine.

What are the factors that determine the use of alter ego doctrine?

As per the IRM, no one element is significant, but in most situations, some or all of the four considerations are utilized to determine to alter ego:

• Combining corporate and personal finances, as well as using company cash to cover personal costs
• Unsecured, interest-free loans made between a company and its owner
• The taxpayer is a stakeholder, employee, or official of the corporation, or has significant control over its activities in any other way.
• The company is undercapitalized in comparison to its reasonably predicted risks.
• Failure to observe the procedures necessary for conducting corporation
• Continued treatment of the company as a corporation results in unjust or “basic unfairness.”

According to the IRM, the alter ego issue should be decided using federal legal principles rather than state law, as detailed in Chief Attorney Notice CC-2012-002. Most federal courts, however, approach alter ego concerns by using either state legislation or both state and federal law.

How does the IRS collect tax from businesses?

Numerous small business owners incorporate their businesses as companies to protect themselves from liability for their company’s debts. However, these corporate structures can occasionally provide their owners with a false feeling of security, failing to take the required precautions to keep their organization’s money distinct from their personal. When these companies have tax problems, the IRS can use the “alternate ego” theory to claim from the shareholders of a legally valid corporation.

While companies are frequently formed to separate the business from its owners, the IRS as well as other creditors can use the alter ego concept to classify all of the owner’s resources as those of the firm.

The alter ego concept is based on the idea that the financial operations of a firm and its owners are so inextricably linked that they ought to no longer be recognised as distinct entities.

A federal court upheld IRS validity to collect taxes

A noteworthy example is a March ruling by the United States U.s. District court of Arizona. TBS Properties LLC v. U.S., CV-20-00195-PHX-DWL (D. Ariz. Mar. 15, 2022), the court determined that regardless of whether state or federal law is used, the IRS must prove two factors for a determination of alter ego liability:

• The proprietor exercised complete control over the firm.
• Recognizing the company as a separate entity would encourage fraud or injustice.
• The IRS was judged to have proven both components of the case by the court.