Putting Lipstick On A Pig: Successor & Alter Ego Determinations

A man in a suit and tie arranging wooden blocks with miniature people on themIn the context of tax liabilities, it’s essential to grasp the concept of successorship and alter ego determinations. You can’t just close down a company with substantial tax debts, establish a new company with a different Employer Identification Number (EIN), and continue business as usual. This approach is often seen as an attempt to evade tax responsibilities and it doesn’t work. It’s akin to putting lipstick on a pig – while you may try to make it look otherwise, the core company remains unchanged.

The IRS takes a keen interest in cases where a company changes EINs but retains nearly identical operational elements, including the owner, equipment, clients, and more. In such cases, the IRS may label it as an alter ego or successor entity. This implies they can shift the outstanding tax balances from the old entity to the new one, along with penalties and interest. And in the worst instances, this move could even trigger a criminal investigation.

The Impact Of Successor & Alter Ego Determination On Your Tax Liability

The main purpose of creating separate business entities is to shield individuals from civil liabilities and, to some extent, taxation liabilities arising from business operations. However, these entities can’t be misused to evade tax payments or obscure a business’s tax obligations. So when the IRS identifies an alter ego or successor, it marks a significant development in the collections process.

If a revenue officer suspects that an entity might be an alter ego or successor, they must go through a legal process to confirm their suspicions, including a comprehensive review by the IRS legal department. If your business structure is legitimate, (for example, if it involves a parent company and its subsidiary), and the revenue officer is merely investigating for irregularities, a tax attorney can help clarify the situation and prove that there is no alter ego or successor relationship.

However, addressing this matter aggressively and proactively is crucial because the determination process often happens discreetly. If a revenue officer informs you or your CPA that they are looking into successorship, it’s advisable to involve a tax attorney immediately to ensure you can mount a strong defense if there are valid reasons to do so.

When Legal Protections & Tax Liabilities Can Be Transferred To A Successor Company

In cases where a company must close and there are outstanding tax liabilities, creative solutions may be necessary to avoid alter ego or successor determinations. For instance, if a business closes because of state unemployment tax issues unrelated to its federal tax obligations, a new entity cannot be formed to sidestep the tax liabilities, as this would result in an alter ego determination.

Instead, a viable approach, which should be discussed with the assigned revenue officer, involves creating a new entity while maintaining an installment agreement for the old entity’s debt. This arrangement can be structured as a third-party assignee agreement. By doing this, you demonstrate to the IRS that you’re not trying to evade taxes but are merely seeking a practical solution to your financial problems. Of course, proper documentation and a cooperative relationship with the IRS are essential for success in such cases.

This strategy allows the new entity to move forward without the burden of the old entity’s tax lien, making it easier to secure loans or financing. It’s a win-win situation, as the IRS continues to receive payments, and you can continue your business activities without unnecessary impediments.

The Role Of Due Diligence In Determining An Alter Ego

The IRS typically looks for specific indicators when assessing whether an entity is an alter ego or successor. These indicators include similarities in assets, clientele, naming conventions, bank accounts, and phone numbers. The most straightforward case for the IRS to identify is when a new EIN is used, but the rest of the operation remains nearly identical.

However, if there is a legitimate transfer of assets between two completely separate entities, that is a different situation. For example, if one LLC purchases a struggling company, and there is no intent to evade taxes, this is not considered an alter ego relationship. The key is to maintain two genuinely separate entities with distinct operations, bank accounts, client bases, and branding.

The Alter Ego Doctrine And Personal Liability

If you attempt to hide behind another entity, thinking it will shield you from the trust fund assessments or other tax liabilities of the original entity, know that it just doesn’t work. The tax obligations can flow through – and they will if you are found out. A rather amusing, eye-rolling example of this was a short-term client of mine who tried this approach…

This client’s new alter ego business was actually located just one floor up in the same office building as his previous business. When a revenue officer arrived, asking for him, he claimed he wasn’t the person they were looking for and asked the officer to return and find someone else. Of course, when I heard this story, I had to inform the client that I couldn’t represent him anymore because providing false information to the IRS is illegal.

I’m not sure how that situation eventually played out, but telling a revenue officer that you’re not the person they’re looking for while you’re sitting in your alter ego is, to put it lightly, not a recommended approach. In fact, it’s just about the worst way to handle such a situation. If a business owner finds themselves in a scenario with an alter ego or successor assessment and they are an officer of the successor entity, they shouldn’t try to hide it – they should accept that those balances will simply transfer across, and they will be subject to the same trust fund liabilities as before.

Preventative Measures To Avoid Alter Ego Determinations

To prevent alter ego or successor determinations and maintain a clear separation between corporate and personal assets and liabilities, several steps should be taken:

  • When closing one entity and opening another, ensure that the two entities are entirely separate. Do not maintain shared bank accounts or phone numbers.
  • File dissolution paperwork for the old entity.
  • Close bank accounts associated with the old entity.
  • Use different phone numbers and contact information for the new entity.
  • Avoid any actions that might suggest a financial connection between the old and new entities.

Properly addressing these aspects can help you avoid alter ego or successor determinations and maintain a clean separation between corporate and personal assets and liabilities. If a successor entity is necessary, consult with a tax attorney to ensure that the process is carried out correctly and transparently, with all necessary documentation in place to demonstrate compliance with tax laws and regulations.

For more information on Successor And Alter Ego Determinations, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (303) 720-6573 today.