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Entries in tax (1)


Why forming a corporation isn't enough

A recent case out of Washington illustrates why the act of forming a corporation is never enough by itself to protect you and your assets.

Attorney’s firm held liable for failing to pay employment taxes

An attorney formed a corporation to run his law practice. He classified himself as an independent contractor despite being the sole shareholder and performing all the legal services on behalf of the corporation. The IRS argued that the attorney was an employee and the Ninth Circuit upheld a tax court decision that held the corporation liable for failing to withhold and pay employment taxes.

It gets worse — the owner and his wife held liable for the corporation’s debt

While having his firm held liable for employment taxes would have been bad enough for this attorney, it didn’t stop there. The attorney and his wife sought a tax refund in the Court of Federal Claims. The IRS counterclaimed and sought to hold the attorney personally liable for the employment taxes and penalties and interest owed by the corporation, and his wife liable as a holder of community property. The IRS won. 

The Alter Ego Theory

How can the attorney be personally liable for money owed by the corporation? Isn’t that why business people form corporations in the first place? The reality is that there are several theories under which the corporate form can be disregarded. The government was able to hold the attorney and his wife personally liable because the attorney treated the corporation like his alter ego. In other words, the attorney acted like the corporation was an extension of himself, and not like it was a separate business entity. He abused the corporate form, purposely used the corporate form to evade its duty to pay taxes, and because the corporation had no assets, holding him personally liable was the only way to prevent an unjustified loss by the government.

What factors did the court consider?

  • The attorney was the sole shareholder and officer. He and his wife totally controlled the corporation.
  • The corporation was just a shell. It had no bank account. It had no assets, furniture, or leases.
  • The corporation was dependent on the attorney and his wife for credit and liquidity.
  • The corporation held no meetings, not even to elect officers.
  • The corporation wrote checks to the attorney, his wife, and their personal creditors.
  • These payments were characterized as loans, but no 1099s or W-2s were issued.
  • The attorney admitted the corporation was a disregarded entity.


What about the wife?

Why was the judgment enforceable against the community? Because Washington is a community property state. Under community property law, the debts of one spouse can often be held against the other. In this case, the wrongful acts benefited the community, so the community was liable. (Corporate funds were used to pay the personal creditors of the couple.)

The moral of the story

Corporations aren’t magic. A corporation only protects its shareholders if the corporation plays by the rules. Filing the articles of incorporation with the Secretary of State is only the very first step in protecting your personal assets from your business liabilities. And protecting your business assets from your personal liabilities. If any of the factors listed above sounds like how you run your business, consult an attorney to learn how you can better protect yourself.