What is an “alter ego”? The phrase is Latin, translating to “second me”, “another me” or “other me”. In the federal tax context, the alter ego doctrine comes into play when the IRS believes that a person or entity should be considered “one and the same entity” as the taxpayer in the eyes of the law, allowing the IRS to collect the tax payable from either the taxpayer or the alter ego of the taxpayer.
What is the alter ego doctrine?
Under the alter ego doctrine, the IRS can seize property held in the name of a third party if the third party holds the property as an alter ego of the taxpayer. That is, the law may authorize the IRS to levy on property or rights in property held by a taxpayer’s alter ego entity (for example, a trust, corporation, or LLC) to recover the tax payable by the taxpayer.
Simply put, for tax collection purposes, a taxpayer and their alter ego are considered one and the same person – and their assets are available to the IRS to collect the taxpayer’s tax liability.
The theory underlying the doctrine is largely based on the premise that the taxpayer and the alter ego are so intertwined that their financial affairs cannot or should not be separated. As such, its application focuses on the relationship between the taxpayer and the potential alter ego.
The Doctrine of the Candidates Compare
The doctrine of the alter ego has several elements in common with the doctrine of the candidate. It differs from the Nominee Doctrine mainly in emphasis: the Nominee Doctrine focuses on the relationship between the taxpayer and the property, for example, where a taxpayer places legal title to the property in the hands of a third party (such as an LLC or trust) while retaining beneficial use and ownership. The doctrine of the candidates, in other words, focuses on particular goods.
The alter ego doctrine, on the other hand, treats an entity as if it were the taxpayer for tax collection purposes. It is not applied on a property-by-property basis; rather, it potentially applies to all of the alter ego’s possessions.
When does the Alter Ego doctrine apply?
The doctrine is based on equity. And, thus, the courts have authorized its application “whenever necessary to avoid injustice” or when public order requires it. For example, courts have allowed the IRS to invoke the alter ego doctrine when a corporation has been used to “evade a public obligation, such as paying taxes” or when a taxpayer has ” constructs paper entities to avoid the imposition or payment of taxes when such entities are without economic substance. Under these circumstances, the federal courts allowed the IRS to pierce the corporate veil in order to collect taxes.
What factors give rise to Alter Ego?
The existence of an alter ego relationship between a taxpayer and another entity (for example, a corporation, trust, individual or other entity) is based on the facts and circumstances. For example, the Fifth Circuit Court of Appeals has held that the following factors are important in establishing such a relationship:
- whether the taxpayer has spent personal funds on property titled in the name of the entity;
- whether the taxpayer enjoyed the benefit and use of the property;
- if there was a close family relationship between the taxpayer and the owner of the property;
- whether the taxpayer exercised dominance and control over the property;
- whether the entity maintained its own books and records, including bank accounts;
- whether funds were transferred between the taxpayer and the entity showing a mix of assets; and
- whether the entity has its own separate existence and identity.
Other courts have emphasized that the following facts are important to the analysis of a federal tax case:
- the taxpayer treating the property and assets of the entity as its own;
- purchasing the other entity’s insurance on behalf of the taxpayer;
- the absence of internal controls in the other entity;
- the use of the other entity’s funds to pay the taxpayer’s expenses;
- the close family ties between the taxpayer and the managers of the other entity;
- the transfer of ownership between the taxpayer and the other entity for little or no consideration;
- the personalized license plate of the other entity’s car bearing the taxpayer’s name; and
- the other entity’s funds fully support the taxpayer in the manner the taxpayer directed.
 In theory, unlike section 6901, the doctrine does not impose the liability of a defaulting taxpayer on another person, but treats an entity as the taxpayer for tax collection purposes. [View source.]