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IBA: The Corporate Veil Wears Thin with the IRS

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By Adam D. Christensen, Dutton Legal Group LLC
 

christensen-adam-mug.jpg Christensen

The legal metaphor “corporate veil” is doubly a tantalizing legal term of art and an effective marketing tool to illustrate to potential clients the benefits of corporate formation.

But attorneys and their clients should not rely on this emblematic security blanket because the country’s most notorious creditor, the Internal Revenue Service, can slice it to shreds with devastating ease.

Section 6672 of the Internal Revenue Code authorizes the IRS to assess the Trust Fund Recovery Penalty (“TFRP”) against any responsible owner, officer, or other party responsible for collecting, accounting, or paying taxes held in trust by a business. The most common corporate trust fund taxes are employment taxes – withholdings and employee shares of Medicare and FICA – excise taxes, and sales taxes.

The amount of the TFRP is equal to the total trust taxes the business collected but willfully failed to turn over to the IRS. Depending on how far behind the business was on its trust fund taxes, the assessment can easily reach six figures or more.

As is the case with most IRS penalty assessments, “willfulness” is broadly defined to include truly nefarious actions (absconding to Tahiti with the taxes) and comparatively innocuous ones (using the taxes to pay other business liabilities such as wages themselves).

To review, the concept behind the “corporate veil” is that owners and officers of an incorporated entity (Inc., LLC, LLP, etc.) can shield themselves from personal liability for even the business’s willful actions, including contract defaults, most torts, and failure to pay debts, including taxes. When a lawsuit is filed against the business that includes its owners/officers as individual defendants, the daunting burden to “pierce the corporate veil” lies with the plaintiff. This burden is so great that, realistically, only plaintiffs with means or evidence of owner/officer malfeasance will be able to keep the individual defendants from being dismissed.

However, the IRS does not have to overcome this burden to assess the TFRP. This could mean massive personal liability assessments against owners, officers, and even accountants and corporate counsel, who exert control over the taxes held in trust by the business. Here is where the “corporate veil” unravels quickly.

When a business fail to pay its trust fund tax liabilities, an IRS Revenue Officer can be assigned to investigate in as little as 60 days. Once contacted by the Revenue Officer, the business will have a brief opportunity to pay its debts in full, usually 30 days. If it cannot, the Officer will move forward with TFRP assessment.

First, interviews are held between the Revenue Officer and any person involved in the operations of the business. Typically, this includes all business owners and officers. However, the IRS will also seek to assess the TFRP against in-house accountants and attorneys who exhibit “significant control” over the business’s finances. Indeed, in sole proprietorships and closely-held business, the IRS may demand to interview owner/officer spouses, even if the spouse is not affiliated with the business.

Though counsel may represent any individual at the TFRP interview, the IRS will insist on a face-to-face or telephone interview with the alleged responsible party. If the individual fails to agree to this arrangement, the IRS will use its summons authority to compel the individual’s participation.

If the Revenue Officer finds sufficient evidence to assess the TFRP against one or more individuals, the IRS will issue Letter 1153, giving the parties 90 days to petition the United States Tax Court to appeal the assessment. If no appeal is filed, the TFRP is assessed on day 91.

To be clear, no new liability is assessed by the TFRP. Rather, a portion of the business’s liability is shifted to the responsible individuals. However, to the blindsided business owner, this is small comfort given the federal tax liens that may be filed and the potential for IRS levy and garnishment actions. Even if the business closes, the TFRP remains. What’s more, the TFRP, unlike some personal income tax debts, is not dischargeable in a bankruptcy.

Despite the veil’s assumed protections, the only cure for the TFRP is to negotiate a payment plan with the IRS collections department to pay the underlying debt as well as the penalty, a painful process without a catchy metaphor.•

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  1. I grew up on a farm and live in the county and it's interesting that the big industrial farmers like Jeff Shoaf don't live next to their industrial operations...

  2. So that none are misinformed by my posting wihtout a non de plume here, please allow me to state that I am NOT an Indiana licensed attorney, although I am an Indiana resident approved to practice law and represent clients in Indiana's fed court of Nth Dist and before the 7th circuit. I remain licensed in KS, since 1996, no discipline. This must be clarified since the IN court records will reveal that I did sit for and pass the Indiana bar last February. Yet be not confused by the fact that I was so allowed to be tested .... I am not, to be clear in the service of my duty to be absolutely candid about this, I AM NOT a member of the Indiana bar, and might never be so licensed given my unrepented from errors of thought documented in this opinion, at fn2, which likely supports Mr Smith's initial post in this thread: http://caselaw.findlaw.com/us-7th-circuit/1592921.html

  3. When I served the State of Kansas as Deputy AG over Consumer Protection & Antitrust for four years, supervising 20 special agents and assistant attorneys general (back before the IBLE denied me the right to practice law in Indiana for not having the right stuff and pretty much crushed my legal career) we had a saying around the office: Resist the lure of the ring!!! It was a take off on Tolkiem, the idea that absolute power (I signed investigative subpoenas as a judge would in many other contexts, no need to show probable cause)could corrupt absolutely. We feared that we would overreach constitutional limits if not reminded, over and over, to be mindful to not do so. Our approach in so challenging one another was Madisonian, as the following quotes from the Father of our Constitution reveal: The essence of Government is power; and power, lodged as it must be in human hands, will ever be liable to abuse. We are right to take alarm at the first experiment upon our liberties. I believe there are more instances of the abridgement of freedom of the people by gradual and silent encroachments by those in power than by violent and sudden usurpations. Liberty may be endangered by the abuse of liberty, but also by the abuse of power. All men having power ought to be mistrusted. -- James Madison, Federalist Papers and other sources: http://www.constitution.org/jm/jm_quotes.htm RESIST THE LURE OF THE RING ALL YE WITH POLITICAL OR JUDICIAL POWER!

  4. My dear Mr Smith, I respect your opinions and much enjoy your posts here. We do differ on our view of the benefits and viability of the American Experiment in Ordered Liberty. While I do agree that it could be better, and that your points in criticism are well taken, Utopia does indeed mean nowhere. I think Madison, Jefferson, Adams and company got it about as good as it gets in a fallen post-Enlightenment social order. That said, a constitution only protects the citizens if it is followed. We currently have a bevy of public officials and judicial agents who believe that their subjectivism, their personal ideology, their elitist fears and concerns and cause celebs trump the constitutions of our forefathers. This is most troubling. More to follow in the next post on that subject.

  5. Yep I am not Bryan Brown. Bryan you appear to be a bigger believer in the Constitution than I am. Were I still a big believer then I might be using my real name like you. Personally, I am no longer a fan of secularism. I favor the confessional state. In religious mattes, it seems to me that social diversity is chaos and conflict, while uniformity is order and peace.... secularism has been imposed by America on other nations now by force and that has not exactly worked out very well.... I think the American historical experiment with disestablishmentarianism is withering on the vine before our eyes..... Since I do not know if that is OK for an officially licensed lawyer to say, I keep the nom de plume.

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