Criminal Defense Lawyers

What is Alter Ego Tax Fraud

Alter ego tax fraud is when the IRS ignores your corporate structure and treats you and your business as the same person. That definition sounds straightforward. But here’s what nobody tells you: the very things you do to maintain control over your company are exactly what expose you to personal liability. You formed an LLC or corporation specifically to protect yourself. The way you treat that entity is what makes the protection disappear. You thought you had a shield. You built a target.

Welcome to Spodek Law Group. We’re putting this information on our website because alter ego liability is one of those areas where business owners genuinely don’t understand their exposure until it’s too late. They think the corporate form protects them. They think as long as they filed the right paperwork, their personal assets are safe. That’s completely wrong. The IRS doesn’t care about your formation documents. They care about your behavior. Todd Spodek has represented business owners who were shocked to discover that their house, their personal bank accounts, and their investments were all on the table because of how they ran their company. The corporate veil they thought existed was transparent.

The legal doctrine is called “piercing the corporate veil.” Under this doctrine, the IRS can reach through your LLC or corporation and seize your personal assets to satisfy business tax debts. It works in reverse too – they can take company assets to pay your personal taxes. The liability flows in both directions. And once the IRS establishes alter ego, you’re not fighting a corporate tax problem. You’re fighting for everything you own.

The Corporate Protection That Doesn’t Protect

Heres the paradox that destroys business owners. You form a corporation or LLC specifically to create limited liability. Thats the whole point. If the business fails or gets sued, your personal assets are supposed to be protected. The business is one legal person. You are another. The debts of one shouldn’t be the debts of the other.

But heres what actually happens. You run the business. You make all the decisions. Maybe your the sole shareholder or the only member of the LLC. The business has a bank account, but sometimes you use it to pay personal expenses. Sometimes you deposit personal funds into it when the business needs cash. You never really hold board meetings because whats the point when your the only one there. Corporate formalities feel like bureaucratic nonsense for a business you own completely.

Every one of these behaviors creates evidence that you and the business are the same person. The corporate form exists on paper. In reality, theres no seperation. And when the IRS comes to collect taxes the business owes, they dont see two seperate entities. They see one person hiding behind paperwork. The protection you formed the company to create is exactly what your behavior destroyed.

What “Alter Ego” Actually Means

Heres how the IRS actually defines alter ego. The legal standard has two elements. First, theres “such unity of interest and ownership that the individuality or separateness of the person and the entity has ceased.” Second, “adherence to the fiction of separate existence would sanction fraud or promote injustice.”

In plain English: you and the business are so intertwined that treating you as separate people would be unfair. The question isnt whether you legally formed the entity. Its whether you actually treated it like a separate entity. Formation is irrelevant. Behavior is everything.

And heres something that should concern every business owner. The IRS uses federal common law to determine alter ego – not state law. Many in the legal profession would argue that state law should govern. But the IRS Chief Counsel has published the opinion that federal common law applies. This means the state-level protections you think you have may not help you when the IRS comes to collect.

The Factors That Expose You

Heres the irony thats impossible to escape. The things you do to maintain control over your business are the exact factors that establish alter ego. Complete control? Thats a factor. Sole shareholder or member? Thats a factor. Making all the decisions? Thats a factor. Every sign of successful business ownership becomes evidence of alter ego liability.

The IRS Internal Revenue Manual – specifically Section 5.17.14 – lays out five different theories for third-party liability: transferee, fiduciary, successor, nominee, and alter ego. Each theory has its own elements. For alter ego specificaly, investigators look at:

Did you commingle funds – mixing personal and business money in the same accounts? Did you fail to maintain corporate formalities – skipping board meetings, not keeping corporate records? Did you undercapitalize the entity – never putting in enough capital to actually operate as a real business? Did you use corporate assets for personal purposes? Did you make unsecured, interest-free loans between yourself and the company?

Every “yes” answer builds the case. Every informal action that felt normal when you did it becomes evidence. The loans you made to your business to keep it alive? Those become evidence that you and the business are the same person. The way you used the corporate account like your personal checking account? Thats the unity of interest the IRS needs to prove.

How the IRS Actually Pierces the Veil

Heres something important about how alter ego cases actually proceed. The IRS dosent just decide your company is your alter ego and start seizing assets. There procedural requirements. Area Counsel must approve alter ego collection actions before they proceed.

This matters because it means these cases are carefully vetted. The IRS isn’t taking shots in the dark. By the time they initiate alter ego collection, they’ve already built there case. They’ve analyzed the factors. They’ve concluded that the evidence supports treating you and your business as one person. The fact that Area Counsel approval is required means this isn’t a routine collection tactic – its a serious allegation with significant legal review.

The IRS will look at bank records. They will examine how funds moved between personal and business accounts. They will review corporate records – or notice the absence of corporate records. They will document every instance of commingling, every personal expense paid with corporate funds, every loan without proper documentation. By the time you realize theres a problem, they already have years of evidence.

The Single-Member LLC Trap

Heres the uncomfortable truth about business structure. Single-member LLCs and sole shareholder corporations are the most vulnerable to alter ego claims. The simplest structure is the most dangerous.

Think about why this is true. When your the only owner, theres nobody to have meetings with. Nobody to document decisions to. Nobody to maintain formality with. The behaviors that protect against alter ego – seperate records, formal meetings, documented decisions, arms-length transactions – feel pointless when your the only person involved. Why write a resolution to yourself? Why hold a board meeting with yourself?

But this is exactly what creates the exposure. A corporation with multiple shareholders has built-in formality. Decisions have to be communicated. Records have to be maintained. A single-member LLC has none of those natural constraints. The absence of formality becomes the evidence of alter ego.

The corporate veil that was supposed to protect you from creditors becomes transparent when you fail to treat the entity as seperate from yourself. Your running the business the way most small business owners run there businesses. And thats precisely the problem.

Trust Fund Taxes – The Money That Isn’t Yours

Heres something that makes alter ego even more dangerous for employers. Employment taxes – the income taxes and FICA taxes you withhold from employees paychecks – are called “trust fund taxes.” There called that becuase there not your money. There your employees money that your required to hold in trust and remit to the government.

When you fail to pay over trust fund taxes, your not just failing to pay a business debt. Your failing to remit money that was never yours. The IRS treats this differently then ordinary tax debt. Under the Trust Fund Recovery Penalty, responsible persons can be held personaly liable for 100% of the unpaid trust fund taxes. Not a percentage. Not a reduced amount. Dollar for dollar, the full amount.

And heres the part that should terrify every business owner with employees. The Trust Fund Recovery Penalty applies regardless of corporate form. It dosent matter that you had an LLC. It dosent matter that you incorporated. If your a “responsible person” – meaning you had authority to direct which creditors get paid – and you willfully failed to remit the trust fund taxes, your personaly liable.

The criminal penalty under IRC Section 7202 makes this even worse. Willful failure to collect or pay over trust fund taxes is a felony. Up to $10,000 in fines. Up to 5 years in federal prison. For each violation. The corporate form dosent protect you from criminal liability. Your looking at personal financial ruin AND potential prison time.

When Business Owners Go to Prison

Lets look at what happens to business owners who thought there corporate structure would protect them.

Arthur Dale Lothringer was the sole shareholder, officer, and director of Pick-Ups, Inc. – a used car business in Texas. He had complete dominion and control over the company. Pick-Ups owed more then $1.5 million in federal taxes. The IRS argued that the company was Lothringers alter ego.

The district court agreed. The Fifth Circuit Court of Appeals upheld the ruling. Lothringer was held personaly liable for the corporations $1.8 million tax debt. The factors? He was the sole shareholder. He exercised complete control. The company failed to observe corporate formalities. He loaned substantial amounts of money to the business. The corporate bank account was used to pay personal loans. Every behavior that felt normal to a business owner became evidence against him.

Phillip R. Wasserman was a former member of the Florida Bar. He commingled business and personal funds in a fraud scheme. The investigation revealed his lack of bookkeeping, his failure to track investment funds, and his mixing of business and personal finances. He got 180 months in federal prison. Thats 15 years. For someone who thought the corporate structure would provide protection.

The Reverse Piercing Problem

Heres something most business owners dont understand. The liability flows both directions. Traditional piercing makes you personaly liable for your companys debts. Reverse piercing makes your company liable for your personal debts.

Under reverse piercing, the IRS can seize your companys assets to satisfy YOUR personal tax obligations. You owe personal income taxes? If the IRS establishes alter ego, they can take money from your corporate bank account. They can seize business equipment. They can levy business receivables. The seperation you thought existed between your personal assets and business assets dosent exist when alter ego applies.

This creates a cascade problem. Your company has a tax issue, so your personal assets are exposed. You have a personal tax issue, so your company assets are exposed. Every asset you have – personal or business – becomes available to satisfy any tax debt. The corporate form that was supposed to create seperation creates nothing.

The IRS Collection Machine

Heres something business owners dont understand about alter ego collection. The IRS has a systematic process for identifying and pursuing these cases. Its not random. Its methodical.

Revenue Officers are trained to look for alter ego indicators. When they see a business tax debt and a business owner with personal assets, they start examining the relationship between the two. Bank records get subpoenaed. Corporate documents get reviewed. The absence of corporate formalities gets documented. Every informal action you took becomes evidence in a file.

The IRS Internal Revenue Manual contains specific guidance on alter ego collection. Section 5.17.14 lays out exactly how Revenue Officers should analyze these cases. What factors to look for. What evidence to gather. How to build the case. By the time you realize theres a problem, the IRS has been building there file for months or years.

And heres the part that should terrify every business owner. Once the IRS establishes alter ego, they can pursue collection against all your personal assets. Your house. Your investment accounts. Your retirement savings. Everything you thought was protected by the corporate form becomes available to satisfy business tax debts. The collection actions can proceed without filing a lawsuit – the IRS can levy bank accounts and file liens administrativly.

The Conviction Reality

IRS Criminal Investigation has a 90% conviction rate on cases they accept for prosecution. Let that sink in. Nine out of ten people charged are convicted. The IRS dosent bring weak cases. By the time charges are filed, theyve already built an airtight case with years of evidence.

For alter ego cases specificaly, the evidence is often overwhelming. Bank records show commingling. Lack of corporate records shows failure to maintain formalities. Pattern of personal use of corporate assets establishes unity of interest. The facts speak for themselves. What defense do you have when the bank statements show exactly what happened?

The Trust Fund Recovery Penalty creates an additional layer of liability. Even if your never criminaly prosecuted, your still personaly liable for 100% of the unpaid employment taxes. Plus penalties. Plus interest. The amount compounds while the case proceeds. By the time resolution comes, the original tax debt may have doubled or tripled.

The Formality Fiction

Heres what most business owners get wrong about corporate formalities. They think formalities are optional paperwork. They think as long as the business makes money and pays taxes, the formalities dont matter. Thats exactly backwards.

Corporate formalities are what create the legal seperation between you and your business. Board meetings. Corporate resolutions. Documented decisions. Seperate bank accounts with no commingling. These arent bureaucratic requirements – there the foundation of limited liability. Without them, the corporate form is just paper.

The irony is brutal. Entrepreneurs work 80 hour weeks to build there businesses. They pour everything into making the company succeed. But they dont spend 2 hours a year on corporate formalities. They dont hold annual meetings. They dont document major decisions. They treat the business bank account like there personal checking account. Every shortcut feels reasonable in the moment. Every shortcut builds the alter ego case.

Think about what happens when the IRS audits your business. They ask for corporate minutes. You dont have any. They ask for board resolutions authorizing major transactions. You never created them. They ask to see how capital contributions and loans were documented. There were no documents. Every missing piece of paper confirms that you never treated the entity as seperate from yourself.

The formalities feel pointless until there the only thing standing between you and personal liability. Then there priceless. And by then, its too late to create them.

What This Means For Your Business

If your running a business – especialy a single-member LLC or sole shareholder corporation – you need to understand how easily alter ego liability can attach.

Heres the cascade that destroys business owners. You commingle personal and business funds becuase its convienient. You fail to maintain corporate formalities becuase they seem pointless when your the only owner. The IRS audits your business or initiates collection. They find alter ego factors. Suddenly your personal assets are on the table for what you thought was a business debt.

The purpose of incorporating was limited liability. The way you ran the business defeated that purpose. You formed the entity to protect yourself. You operated it in a way that eliminated the protection.

Clients come to Spodek Law Group after discovering there personal assets are at risk for business tax debts. They thought the LLC protected them. They thought the corporate form created a barrier. They discovered that there behavior had eliminated the barrier years ago – and now the IRS is reaching through the corporate form to seize there house, there savings, there investments.

If your running a business and your not maintaining strict seperation between personal and business finances, you need to understand the exposure. If the IRS is already pursuing collection against your business, you need to understand whether alter ego arguments are on the table. If you have unpaid employment taxes, you need to understand that the Trust Fund Recovery Penalty can make you personaly liable regardless of corporate form.

Todd Spodek has handled cases exactly like this. We understand how the IRS builds alter ego cases, what evidence they use, and were the defenses might be. If your facing potential alter ego liability, the question is whether to address it proactivly or wait until collection actions begin.

Call us at 212-300-5196. The consultation is free. Loosing your personal assets becuase of how you ran your business isnt.