In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses a recent court case, TBS Props. v. United States, alter ego, and how the Court’s decision could affect how protection of your assets could be affected.
New Shocking Creditor and Asset Protection Case Every Business Owner Must Know
Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial, and welcome to another episode of Adam Talks. Well, you probably know that on most Adam Talk episodes, I tend to focus on retirement topics, mostly self-directed retirement topics, alternative asset investment subjects. But, on today’s podcast, I wanted to explore a different topic, a topic that I think has valuable significance and potential impact on most business owners. Okay and it involves a recent case that came out towards the end of March 2022, and it surrounds essentially asset and credit protection.
So just in gist, the case is TBS Properties v. United States, and essentially it’s a summary judgment case, which you’ll see, the government won on one side and the taxpayer won on the other. But, the idea of this case is how protected are your assets held outside of a business? And most people think, hey, I have an entity here, whether it’s an LLC, a corporation; so anything I do outside of that entity should be protected from creditor and asset attack. In most cases, yes, that’s the case. But there’s a doctrine called alter ego, which I’ll get into a few minutes, which is scary and super important to focus on. If you are a business owner and have other assets outside your business, you’re going to want to listen up, or if you’re watching on YouTube, spend some time watching me because this is really important stuff and kind of scary actually, that this is possible.
So, let me just kind of give you some overall facts here. I’m not going to go into every detail of this case, but just enough to bring out the important facts of this case. Then we’ll talk about alter ego and kind of what it means for a business owner. So essentially, obviously, the IRS has super broad power to impose federal tax liens. Okay? This is especially true on property interest; if you have a conflict with the IRS, they are extremely powerful and attempting to go out and get your assets to meet that demand. Okay, so the threshold for determining the alter ego liability, essentially the ability for the IRS to go out and get other assets outside of that entity. It’s essentially a very unclear doctrine. It’s largely based on facts and circumstances. But in this case, the TBS property, I think, really gives you a good highlight of their power.
So in this case, an Arizona corporation, said corp., should have limited liability protection, was found liable for about $150,000 in unpaid taxes from 2015 to 2017. Corporation owned and operated a restaurant in the Phoenix area, and the real property in which the restaurant operated was held in a separate LLC. So, you have a restaurant and then the real estate underneath is held by totally separate LLC. The idea is to bifurcate risk, so God forbid, there’s a credit attack on the restaurant, you can’t attach the real estate and vice versa.
Corporation was owned by a family trust and the LLC was owned by a marital trust. And we’ll see what that means. The same taxpayers, and this is an important point, the same taxpayers settled both the family trust and the marital trust. So, they created both trusts and both trust have the same co-trustees. Okay, still separate entities, right? They’re still a corporation, LLC, but, they were owned by these trusts, which essentially were the same people, but still again limited liability protection. So, in an effort for the IRS to collect the corporations’ unpaid taxes, that $150,000, the IRS entered a lien against the real property owned by the LLC, even though it’s totally separate from the corporation. And they asserted that the LLC was the alter ego of the corporation and hence, was liable for its debts.
And then the court denied the LLC’s motion for summary judgment, holding that the IRS proffered sufficient evidence to support its alter ego theory. So, the court in summary judgment, which means essentially trying to end the case, they ruled for the IRS in this alter ego doctrine. In particular, the court relied on evidence that, and we’ll talk about this in more detail, the entities shared common officers, directors and owners. The entities failed to enter a formal lease agreement, and the corporation routinely transfer money to the LLC without appropriate documentation.
Three things that a lot of brothers-sister companies do. If you own a company A and then you have a company B, a lot of this stuff happens; you have common owners, common officers, you may move money between companies without proper documentation, and there may be a lease that’s entered into that doesn’t have a formal agreement. So, this is something that could happen to many, many businesses. So, it’s important to focus on this and listen up.
So, what is alter ego or piercing the corporate veil? You’ve probably heard the doctrine, piercing the corporate veil; it’s a more popular concept than alter ego doctrine, but it really means the same thing. So, under the doctrine of alter ego, individuals may be liable for the actions of their corporations in certain circumstances. General question is whether the individual, such as the shareholder, officer or director, abused the corporate forums such that it would be unfair to shield that individual from personal liability. While there are no rigid requirements for the alter ego doctrine, considerations include whether a) the individual commingled his or her personal funds of the corp, b) the corporation is under funded, and c) then they’ll treat the corporation’s funds as their own, or d) the corporate formalities were observed, were not observed.
So, those are the things that potentially a court can look into whether they could collapse the corporate wall and treat multiple entities as one, so that the IRS or a third party creditor can potentially go after other assets. So piercing the corporate veil is a very serious concern for any business owner. And this case is important because the facts are super common. I’ve seen these facts in so many cases where you have multiple businesses that are owned by the same people and, kind of, money goes between businesses, and there’s no formal documentation or formal contracts, formal agreements, and then bang, one company runs into an issue, whether it’s a suit, creditor attack, and now there’s a creditor out there, whether it’s the IRS, or some third party that wants to go out and get the other assets of that alter ego corporation. And now is that potentially available?
So, this is a wake up call. Any business owner out there needs to focus on this, and they really need to consider corporate formality; having minutes if it’s a corporation, think about writing down leases, contracts, even if it’s a boilerplate contract, have it signed, have it notarized, show that these is a third party. If money’s moved, document it; why did $5,000 go from company A to B? Was it services rendered? Was it accounts receivable? Whatever it is, document it. You want to show that these two companies are separate, even if you have separate, obviously you need separate bank accounts, but even separate banks, right? You want to show that there’s a separation distinction between these companies.
So, let me go into the facts, and then we’ll kind of talk about the Court’s decision and talk about some of the elements to look at, whether you may be into a alter ego situation. So, I’m just going to kind of skim the facts. For 30 years or so, this family, the Perry family, they owned a whole bunch of restaurants. And basically the real estate where the restaurants were located were generally held by these separate LLCs. Between 2015 and 17, this company, Radon Enterprises, which is an S corp, it’s associated with the Perry’s restaurants, they amassed about $150,000 in liabilities. So then, the IRS put a lien on the property where the Radon does business. This property is owned by the Perry’s LLC: TBS Properties, LLC. Again, you have a corporation owned by the Perrys. You have an LLC owned by the Perrys, both were owned by trusts of the Perrys. Same officers, same owners, okay?
In this action, TBS seeked to quititle to the encumbered property. So the Perrys basically said, hey, you can’t go after the LLC because it’s a different entity than Radon Enterprises, where the restaurant was located. So in response, the IRS asserted a counterclaim, seeking a declaration that the LLC may be held responsible for the corporation’s debt pursuant to three theories. One, fraudulent transfer, which they lost. Two, alter ego, which they won, and three, the nominee, which isn’t relevant, because as long as they won one, this case was going to get pushed out of summary judgment.
So, let’s focus on alter ego. I’m not going to really focus on the fraudulent transfer, because there wasn’t really much of a fact pattern here. But it’s important to focus on what the court talked about – alter ego. Okay, so alter ego, essentially is, in the briefs, both sides eventually agreed that regardless of whether state or federal law is being applicable here, the United States must prove two elements to establish alter ego. One, the unity of control. Basically it’s like one entity. Two, that observance of the corporate form would sanction fraud or promote injustice. So, the fact that the observance of corporate form would create this injustice, whatever that means, we’ll talk about that. So, the TBS, Perrys argued that summary judgement is warranted because the IRS cannot satisfy either element.
As for unity control, the LLC argued that for the relevant factors identified by the Arizona courts, only one common officers and directors is present here. As for fraud and injustice, the TBS contends there’s no evidence that TBS was used in any way other than for a landlord of the property. So, when the corporation made payments directly, the expense was recorded as an expense and reduction in Radon’s cash and it’s books, and when made payment on behalf of the corporation, from the property management company, sometimes made payments on behalf of the corp to the LLC, it was recorded as an expense and an increase in the account.
So, as a disregard entity, since TBS was a single member LLC, TBS reported its operation, including the rent earned from the corp, on its trust tax returns, okay? There was no commingling assets between the different companies that are managed by the management company and the family trust. Okay, so that’s what the taxpayers argument, it’s a pretty good argument.
And as for unity of control, the US argued the following facts. So, they said absence of an executed lease between TBS and the corp, so there was no lease between the restaurant and the LLC, which was stupid, okay? That was something that should have been remedied. Simple documents showing how much the LLC was paying the corp for the property lease should have happened, okay? So, that’s a mistake that was not; ended up being kind of a killer for the taxpayer, but that’s something that was easily corrected.
The uncontested fact that the Perrys controlled all the entities prior to the respective deaths and afterward, common person, the co-trustees, there was control. They went to say all 27 entities owned by the two trusts, fact that both these people referred to as the family business, okay? So, they’re saying basically, there was no lease and they were all the same companies; it’s all common owners, they should be treated as one company. They basically said throughout the family business, they’re common officers, directors and ownership. There’s a failure to maintain corporate formality, a lack of corporate separateness, and a lack of knowledge about the purported corporate separateness.
There are interest-free loans, confusing and unrecorded financial records, and commingling of corporate and personal funds. The lack of board meetings, and as a result, the IRS has shown that there’s unity of control. Okay? So, as for the remaining parts of the alter ego test, the IRS argued that to allow the LLC and its related companies to use the corporate form was to basically allow them to promote injustice and frustrate the IRS’s ability to collect.
They’re saying, you set up these corporations, but they were shams because you basically didn’t respect the corporation formalities, so it would be an injustice to respect the formalities, so we’re not going to respect them. Okay, so what are the Courts say? Basically, in its analysis, they said a corporation will be treated as a separate entity unless sufficient reasons appears to disregard the corporate form. But, when an entity is merely another entity’s alter ego, and when observing the corporate form, would work as an injustice, the Court may properly pierce the corporate veil. This alter ego status exists when such unity of interest and ownership exists that the separate personalities of the corporation cease to exist. Thus, to establish that an entity is liable under the alter ego theory, plaintiff, the IRS, must show that unity of control exists and the observance of the corporate forum would sanction a fraud or promote injustice.
Okay, so as for unity of control, unity and control exists when the parent corp exercises substantial total control over the management and activities of the sub. Factors providing substantiate total control including common officers, directors, parent financing, parents payment of salaries for the sub, and the sub’s failure to maintain formalities. The Court concluded there’s enough evidence, that when construed in the light of the most favorable to the United States, could support a finding that United States favor of the unity of control element of the test was met. So in that case, the LLC lost on summary judgment, because they found that there was unity.
Okay, as for the factors that cut in the US’s favor, first, it’s undisputed the LLC and the corp were owned and controlled by common officers. Both sides agree this was a favor and finding unity of control. Second, the undersigned nature of the lease between the corp and the LLC, can be viewed as a rational fact-finder, as an indication of unity of control. Lack of common corporate formalities was not material, unless otherwise specifying the offering agreement, LLC rules do not require member meetings. So, given the diversity of corporate structure and the range of factual settings with injustice or inequitable results are alleged, it is not surprising that no uniform standard exists for determining whether the lack of corporate formality exists. So, this is an issue best resolved at trial after weighing the evidence, and thus, the summary judgment motion was denied.
Okay, so for fraud or injustice, which is the second prong; for the first prong, they basically said, hey, this is something the Courts need to decide; it’s based off facts, right? There’s no clear facts. The parties haven’t consented to the facts. We need a court to see if there was actual unity. Fraud or injustice – they essentially said there’s no requirement to actually show fraud, but you need to be able to show that there’s some type of promotion of injustice, which is a difficult test to meet. So they said thus, even if TBS was identified, reasons why the IRS may face an uphill climb during future stages of the case while pursuing a nominee claim, the only issue now before the Court is whether such a claim is potential viable under Arizona law. The Court agrees with the IRS that liability is potentially available okay? And basically said the IRS has broad power to impose federal tax liens, and apply to all property taxpayers and clean property, tell by third party as a taxpayer’s nominee.
Okay, so essentially, the Court wasn’t convinced that there was no case here and they basically ruled in favor of the IRS that hey, you need to go to court and you guys need to fight this out and it’s up to the judge to look at the two elements of alter ego, the control and showing the potential fraud. And the Court went into various state law, places in Arizona, suggesting the existence of an unpaid tax or other liability would be sufficient to establish injustice. But, they said this is an area that needs further clarification.
So, looking at this, and just taking the facts in general, looking at it from above, this is kind of scary, right? Because you have two entities commonly owned. A lot of people out there, including myself, have entities that have common ownership. Not all corporate formalities are met, especially if you have a corporation, where there’s actually requirements to have minutes, meetings, annual meetings, where LLCs do not have corporate formality; and then there’s situations where there could be service arrangements or employees shared or even a lease where it’s not actually documented, it’s kind of just agreed upon by the party since it’s mostly common parties. So, you have a situation where corporate formalities may not be satisfied, and then the argument can be, hey, is there kind of a uniform company here? And would it be injustice to respect the corporate form because it’s an illusion that there’s actually a separate corporations? It’s really not. And those are generally facts and circumstances.
So, these are some of the elements to look at. Was there bad faith? Is the individuals contract with another intend to avoid performance of service by using a corporate entity to shield against liability? Right? Did the Perry use an LLC to do that? No, they use the LLC to protect against creditors; they own real estate, so, I don’t think they can prove that. Did the individuals divert assets from a corporation or another person for the detriment of creditors? Probably hard to argue because the rents were still being paid. Determination of the corporation by a few key individuals? Yeah, both companies were owned by a family. Do the individuals and corporations use the same office or business location? Probably, right? Same owners. Did the individuals in the corporation employ the same attorney? Not sure, but that’s an important fact. Did the individuals use the entity to procure labor services and merchandise for another person or entity? Maybe, we’ll see. Did individuals fail to actually capitalize the corporation? Probably not because the corporation was a business, a restaurant. Did individuals fail to maintain minutes in adequate corporate records? That’s possible in the corporation, not the real estate LLC. And will there be inequitable results if the courts fail to pierce? That’s the question, right? Ultimately that’s the question the courts have to decide.
I’m not sure about that. I do think there’s a policy argument that you need to respect the corporate form. If people lose faith that the corporate form will be respected, maybe they’ll stop transacting or not do that activity. So, I think it’s important for business people to have confidence that there is limited liability protection, that different entities they own will be isolated from each other. So, if there’s a debt in one entity, creditors can attack the other. But this case really froze that for a loop. This is very common fact pattern that, as I mentioned, many, many business owners across the country would satisfy common ownership, multiple companies, lack of corporate formality, lack of formal contracts between the companies. So, if you’re listening and kind of shaking in your boots like, I got you, I understand, what you can do.? Simple, right? There’s a few things you can do.
Number one, keep things separate; document things; use different bank accounts; maybe use different lawyers for both companies; different offices, if possible, things like that. Maybe set up different barriers between the companies. Definitely if you have services being performed between the companies, definitely, definitely document them. If you share employees, definitely document them. You want to, you know, be careful, because you do not want creditors to come in and try to attack your other assets, and argue alter ego; piercing the corporate veil doctrine.
So, I usually don’t talk about asset/credit protection, but I really wanted to talk about this case because when I reviewed it, my heart kind of dropped. I was like, oh my God. If the IRS is able to do this and literally attach a lien on an entity that’s totally separate; yeah, it was a real estate under the restaurant, but still a separate entity that should be respected, that’s scary. Because yeah, the IRS has broad powers when it comes to imposing liens, but hey, this is precedent for individual creditors that can go after other alter ego businesses and use, potentially, this case to pierce the corporate veil.
So, even if it’s an Arizona case, the principles in it could apply across the country. So, it’s really important; I don’t want to scare anyone, but this is like a wake up call if you have multiple entities to talk to an attorney, and talk to your business partners, or if it’s just you, document your transactions; the movement of money, any arrangements, any agreements. Keep separate bank accounts, use separate banks, separate lawyers, if possible, separate offices. You do not want to show anything or anyhow that this is a common controlled entity.
Kind of put your hat on and think of yourself as an attorney for a creditor trying to attack your structure, and just kind of, hey, how would they attack it? Oh, they can try to argue we’re using the same mailbox, we use the same lawyer, we use the same bank account, or we don’t have a lease between the companies, or we don’t have a service contract. So, you want to remedy all that before, God forbid, there are any litigation claims.
So, thank you for listening. If you’re watching on YouTube, thank you as well. Again, I thought this was an important case; you can check it out. It’s kind of, it’s like a 30-page opinion. It’s written pretty well; you can skip through a bunch of it and just kind of focus on alter ego. But, it’s TBS, T as in Thomas, B as in Bravo, S as in Sam, TBS Properties LLC versus United States; just came out, March 2022. Again, you can skim some of the facts, but I would focus on the alter ego doctrine, the two elements of unity and the injustice promotion, and kind of see some of the arguments that were put forth by both party and then kind of how the Court ruled that the case should continue and didn’t rule in the taxpayers’ favor for summary judgment.
I did my best to summarize them, and I think I got all the salient and material areas covered, but if you are interested and, again, have a business and potentially of other assets that could come under credit attack, look at this. You also should try to, again, talk to an asset/credit protection lawyer. I’m a tax lawyer. I don’t focus and specialize in asset and credit protection. So, if you are worried about, definitely reach out to an asset and credit protection lawyer and have them review your structure; review your processes, your procedures and make sure you’re doing everything you need to do to show separateness because you don’t want, God forbid, an attorney or the IRS to come in and try to grab assets that you thought were protected but you just kind of did a couple of dumb things or didn’t kind of follow through on a few things, like the lease. There should have absolutely been a written lease between the Perrys, both entities. That’s stupid. Should have had that. If they transferred money, they should have had a rental arrangement, right? Like the lease; use separate bank accounts. I don’t know what they did from a personal standpoint to use some of these assets for personal use, but they did own a property management company. They just needed to be a little bit more organized.
We’ll follow up. It’s curious if the IRS will prevail. I hope they don’t because I think it is important from a business standpoint that assets are protected, especially when there’s no intent to defraud anyone. There was a real, legal reason to have two entities from a limited liability protection and the fact that there’s common ownership shouldn’t be material. They didn’t have a lease, but the payments were happening and the structure, in substance, and I think in form were respected.
So, to be continued. I will certainly follow this case as it unfolds and report back to all you, but thanks again for spending some time with me today, I really appreciate it. And again, this is a weekly podcast that drops every Wednesday, so check it out. And if you haven’t already, subscribe to IRA Financial, because you can watch this on YouTube whenever you want, or you can obviously download it wherever you download your other podcast. So, be well, take care and talk to you again soon.