Any businesses or corporations that try to hide their tax obligations behind other entities will not be successful under the IRS’ alter ego theory.
The following will explain what the alter ego theory is and how it could be established that third-party business entities will also be obligated for tax indebtedness of the primary organization or individual.
What is an alter ego?
Certain criteria need to be satisfied before it is established that a third-party entity is considered an alter ego. Unity of ownership and interest between the entities has to be established. Another consideration is whether fraud or inequity would be perpetrated if an entity was not established as an alter ego.
There are specific criteria from the Internal Revenue Manual (IRM) 126.96.36.199.2 (10-18-2013) that could establish alter ego status:
- Position of control and authority over the business entity
- Controls the business entity to shield from personal liability
- Financially benefits from the business organization
- Uses the business entity to assume debts or pays the business organization’s debts
What is the IRS alter ego theory?
Once alter egos of establishments or individuals have been determined, the tax or financial obligations of one entity becomes the obligations of all third-party entities or alter egos.
According to the (IRM) 188.8.131.52.5 (09-25-2020):
“The alter ego theory allows collection from all the property of a taxpayer’s alter ego. This theory is based on the premise that the taxpayer and the alter ego are so intermixed that their affairs are not readily separable.”
A prime example
Here is an example of how an alter ego business entity could be determined to share in any financial obligation (taxes or otherwise) to which the primary entity may be indebted.
In the case of Crystallex International Corporation v. Bolivarian Republic of Venezuela, Crystallex, after winning a judgment of $1.2 billion against the Republic of Venezuela, went back to the Delaware District Court. They filed to convince the court that Petróleos de Venezuela, S.A. (PDVSA), the state-owned oil company of Venezuela, was the alter ego of the Republic of Venezuela. The reason they did this was so that they could acquire shares of PDVSA to help satisfy the judgment.
It was determined that PDVSA was an alter ego of Venezuela based on the following factors:
- The amount of economic control over PDVSA the Venezuelan government has
- That profits from PDVSA go to Venezuela’s government
- That the Venezuelan government is heavily involved in the management of PDVSA
As with everything related to taxes and business, the alter ego theory is complicated and difficult to navigate. If you suspect unlawful, unfair, or fraudulent business practices, you should consult a qualified tax attorney.