What is an "alter ego" allegation?
Aside of course being one of several nuanced yet distinct stages of intoxication, when it comes to the IRS it seems from my perspective that there are several elements of the alter ego doctrine that arose out of the California Supreme Court in Minifie V. Rowley, 187 Cal 481, 487 including:
1. domination and control by one person,
2. disregard of corporate formalities,
3. under capitalization or insolvency,
5. asset shifts,
6. interlocking directors and
7. no corporate or partnership income tax returns filed.
Quite often with complicated tax matters involving multiple entities and entity types IRS Examining Agents may be biased towards developing a taxpayer's file based on this doctrine. Once the burden of proof is achieved the outcome for the taxpayer can be quite consequential. The best way to avoid the allegation of course is to behave accordingly which in my reality distills down to two words DON'T COMMINGLE!
The IRS does in my opinion have some burden of proof before unilaterally alleging that you are an alter ego of an entity as spelled out in Minifie V. Rowley, 187 Cal 481, 487 stating:
"Before the acts and obligations of a corporation can be legally recognized as those of a particular person, and vice versa, the following combination of circumstances must be made to appear: first, that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality or separateness, of the said person and corporation has ceased; second, that the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice."
From the lens of IRS Revenue Agents the fraud or promoted injustice would of course be the avoidance of reporting income and paying income tax and quite often when one taxpayer has a multitude of disregarded entities all reporting income and losses through to a personal tax return it can become very easy for your less astute examiners to automatically assume that 'alter egos' exist. This is the main reason why I believe the more complicated tax returns need the caring attention of a LICENSED tax practitioner along with assurances of proper bookkeeping protocols and accounting controls.
Let's break this down..
When it comes to domination or control, this can mean by one person or by related parties including members of the same family (even if you may not be able to tolerate each other's presence on this Earth) which usually manifests itself in commingling of corporate and personal funds; diversion of corporate funds for personal use or use outside of the profit motive of the corporation; AND/OR personal use of corporate assets or payments of personal expenses from corporate funds.
But be careful as it goes deeper to include simply making statements attesting to the fact that there is no difference between yourself personally and the entity and/or holding yourself out personally as being responsible for debts incurred by the corporation. Alarmingly another criteria is whether corporate affairs are conducted at the taxpayer's primary residence. So for those of you considering turning that hobby into a business take care to consider engaging an Enrolled Agent licensed by the US Treasury to practice before the IRS.
Disregarded corporate formalities are easy to identify and are usually the low hanging fruit if you will for IRS Examiners. Basically this means no issued stock, no meetings of shareholders or directors, few or meager minutes recorded of the elected leadership team, failure to maintain arms-length relationships, no market value for stock, and most importantly in my opinion from a tax perspective having corporate funds so expended that there are no liquid assets available for general creditors like the IRS.
After validating under capitalization or insolvency the IRS Examining Agent or Technical Corrections Officer is trained to look for diversions of assets from the corporation to you the primary shareholder that can be identified as being to the detriment of the IRS which can be arguably considered civil fraud that can quickly rise to the threshold of criminal fraud depending on several factors and mitigating circumstances.
So generally speaking be careful in the following regards:
1. how you disclose corporate and partnership statuses to the IRS as well as the various departments of revenue across the US. Consistency is king
2. how you document shifting assets and liabilities to other people as you grow, evolve and reorganize. Or as I like to call it the art of doing a clean and thorough deal.
3. file all required income tax returns always be it for your corporation, partnership, trust - even if the entity had no gross receipts and/or expenses.
Basically whether or not the precepts of alter ego will be applied in an IRS examination cannot be communicated in a specific formula as each IRS audit file develops differently and each IRS Revenue Agent will be investigating from his or her own biased lens. However my experience to date dictates that there are three basic characteristics being sought by the IRS including:
1. establishing common ownership
2. proof of commingling of personal and business funds including payment of personal expenses from corporate funds
3. disregard of corporate formalities
These are all particularly relevant mostly because if you find yourself in an IRS audit or examination statistically speaking the entity in question is probably insolvent or inadequately capitalized due to poor execution which ultimately only adds fuel to the IRS Revenue Agent's fire it seems.