Wednesday, March 16, 2016

IRS Successfully Argues that One Corporation is the “Alter Ego” of the Other, Holding the Newly Created Company Liable for the Tax Debts of the Former

IRS Successfully Argues that One Corporation is the “Alter Ego” of the Other, Holding the Newly Created Company Liable for the Tax Debts of the Former

      From time to time the question is presented, on behalf of a business entity that it owes significant liabilities, including liabilities to the IRS, about the option of simply shutting down that venture, using the net assets to satisfy, typically on a pennies on the dollar basis, the existing creditors, and then starting up essentially the same venture in a new corporate or LLC shell. As is identified in a recent decision, this methodology has significant problems. WRK Rarities LLC v United States, No.4:13-cv-00791, 2016 WL 775422 (N.D. Ohio February 29, 2016).

      It is important to note that this is not a case about “piercing the veil.” In a piercing case, the plaintiff, holding a judgment against the corporation or LLC, seeks to hold the shareholders or members, who otherwise enjoy limited liability, liable upon that obligation. Here, the effort was to hold one company liable for the debts and obligations of the other, even though there was no ownership relationship between them. That this is not a “piercing” case is specifically noted in footnote 1 to the decision. Rather, this analysis involves “alter ego” as that doctrine has been applied under the Internal Revenue Code.
      William R. Kimple, through a pair of acquisitions from the founders, by 1994 was the sole shareholder of Kimple’s Jewelry & Gifts (“KJG”). Apparently (the opinion is nowhere express as to the point), KJG was a C-corporation. In 2005 KJG filed for Chapter 11 bankruptcy. In that proceeding, the IRS filed a proof of claim for unpaid federal taxes including corporate income taxes and employment taxes. Notwithstanding the approval of a plan of reorganization in 2007, KJG failed to perform thereunder, and the bankruptcy was subsequently dismissed. In addition, from 2007 forward, KJG ceased to make quarterly deposits of federal employment taxes, and federal tax liens were ultimately filed. On December 31, 2010, KJG “allegedly” ceased operations.

      However, even as KJG was still in operation, Kimple formed a new LLC, WRK Rarities, LLC, with a d/b/a of Kimple’s Fine Diamonds (“WRK”). WRK would go on to operate a jewelry store from the same location they KJG had operated from since 1957, with Kimple as its sole manager and member. Further, WRK utilized KJG’s signage, furniture and fixtures and continued to utilize the services of the same employees, they having the same titles and salaries they had when working for KJG. WRK even use the same bank as had KJG.
      When, in 2011, the IRS levied on the accounts of KJG, there was little recovery as those accounts contained only minimal funds. Later in 2011, the IRS determined that WRK was “the nominee, alter ego, and/or fraudulent conveyee of KJG,” and proceeded to levy on WRK’s accounts in order to collect on the taxes owed by KJG. Ultimately the IRS would seize WRK’s assets. Thereafter, suit was filed, alleging wrongful levy. From there, this decision was rendered to the government’s motion for summary judgment.
      After determining that it is Ohio law that would govern whether alter ego liability applies, and recognizing the general rule of Ohio that successor liability does not attach in the instance of an asset acquisition, it noted as well that there are at least four exceptions to this rule, and that “a successor corporation may be held liable when (1) the buyer expressly or impliedly agrees to assume such liability, (2) the transaction amounts to a de facto consolidation or merger, (3) the buyer corporation is merely a continuation of the seller corporation, or (4) the transaction is entered into fraudulently for the purpose of escaping liability.” (Citation omitted).
      The court would find it WRK was merely a continuation of KJF
      Citing law to the effect that common ownership is crucial as it would indicate an inadequacy of consideration, in this instance Kimple was the sole owner of both KJG and WRK. Further, the government was able to demonstrate that inadequate consideration was paid for any assets transferred from KJG to WRK.
      With careful and conscientious planning, sometimes it is possible to abandon a failed venture and start a new one. That is possible only with, however, careful planning. In the absence of that planning, successor liability for taxes, and potential successor liability for other claims, should not be treated as a surprise.

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