Generally speaking, the IRS can’t go after a business’s assets when trying to collect the personal tax debts of the business’s owner and/or key employees. Conversely, if a business owes the IRS money, the IRS can’t try to recover that money from the personal assets of the business’s owners or key employees. However, there are definitely exceptions, and it depends on the business’s structure and other factors.
Under certain circumstances, the IRS can place a lien or levy on business property even though it’s an individual who owes the IRS money. This is a relatively rare occurrence, as it depends on a unique set of facts and circumstances. However, if you find yourself in a similar situation, it’s a good idea to talk to a tax lawyer or other professional, such as one from the W Tax Group. Continue reading to learn more about when and why this can happen and how to prevent it.
Key Takeaways
- Unless an exception applies, the IRS will typically respect the limited liability protections offered by the legal separation between a business and its owners.
- The IRS may choose to target personal assets for business tax debts or business assets for personal tax debts if an alter ego situation applies.
- An alter ego situation is when the IRS decides that there shouldn’t be a
- To prevent an alter ego situation, business owners should avoid commingling personal and business funds, honor business formalities, consult with a business tax professional for guidance, and maintain detailed and accurate business records.
Sole Props and Disregarded Entities
If your business is a sole proprietorship, there’s no distinction between you and the business. That means the IRS can go after the business’s assets for your unpaid personal taxes. However, if the business is a limited liability company or corporation, there is a legal distinction between the individual and the business – and in those cases, the IRS will need to jump through more hoops to seize business assets for personal tax liabilities.
Creating a Business as a Legally Distinct Entity
For the most part, courts want to support the idea of limited liability when it comes to running a business. Courts understand that protecting individuals from debts or legal liabilities of businesses helps promote investment and business creation.
This is why there are many limited liability business forms available, such as:
- Corporation
- S Corporation
- Limited Liability Company (LLC)
- Limited Liability Partnership (LLP)
Unfortunately, there are unsavory individuals who exploit these legal liability protections to engage in unfair and/or fraudulent behavior. In these situations, courts will ignore limited liability protections offered by the business. So, a financial debt or legal judgment that might normally only go against the business might also go against the business’s owner. Yet courts aren’t the only entities that sometimes ignore the limited liability protections offered by a particular business structure.
Treating the Business and Individual as the Same Taxpayer for Collection Purposes
Generally speaking, the IRS will respect the legal separation between a business and its owners. This means if the owner has a personal income tax debt, the IRS will only go after that owner’s personal assets. And if there’s a business tax debt, the IRS will only go after business assets.
One potential exception to this is the Trust Fund Recovery Penalty (TFRP). But when the TFRP applies, the IRS is imposing a penalty on an individual for the business’s tax problems, not trying to collect unpaid business taxes from an individual.
The IRS trying to collect a personal tax debt from the business rather than the individual might not seem like a big deal. This might be true from the individual’s perspective, but not the business’s. That’s because if the IRS goes after business property to collect a tax debt that belongs to an individual, it could jeopardize that business’s very existence.
For example, if the IRS were to impose a bank levy on a business account, the business might lack the cash to carry out day-to-day operations, such as paying suppliers or making payroll. Without this cash, the business might lose its workforce and sever its business relationships in a matter of weeks. The good news is that this usually only occurs in unique scenarios, namely when the alter ego doctrine applies.
Alter Ego Theory
This doctrine states that the IRS can ignore the legal separation between two entities if they’re so intertwined that it’s difficult to tell them apart based on their real-world activities or decisions.
For example, imagine a corporation has a single shareholder and both the corporation and shareholder use the same bank account for business and personal transactions. That’s called co-mingling. If such a connection exists between the entities, then the IRS can ignore the legal separation between the two and treat them as a single entity to collect a tax debt belonging to either entity.
There’s no set rule or standard for deciding if a taxpayer and its alter ego should be treated as one for tax enforcement purposes. That being said, the IRS has a list of factors it looks for, with the existence of one or more potentially giving rise to the level of an alter ego situation:
- The business and its owner enter into interest-free and unsecured loans with each other.
- A commingling of business and personal finances, such as sharing a bank account and using personal funds to pay for business expenses or business funds to pay for personal expenses.
- The individual has substantial control over how the business operates.
- A failure to follow corporate formalities, such as paying dividends, issuing stock, or holding shareholder meetings.
- The corporation is unreasonably undercapitalized in relation to its operations and business risks.
- Not applying the alter ego doctrine would result in an unfair or unjust outcome.
Piercing of the Corporate Veil
If an alter ego situation applies and the IRS goes after personal assets to recover a business tax debt, the IRS has decided to “pierce the corporate veil.” If the alter ego situation applies and the IRS instead goes after business assets to recover a personal tax debt, then this is an example of a “reverse piercing of the corporate veil.” No matter which term applies, the IRS has chosen to ignore the legal distinction between a person and another entity, such as a corporation.
How To Protect Business Assets From Personal Tax Liability
The best way to prevent the IRS from invoking the alter ego doctrine is to respect the legal distinction between your business and those running your business and to comply with necessary business formalities. What this requires depends on the type of business you operate.
For example, if you’re operating an LLP, then you probably won’t have bylaws, but you’ll have a partnership agreement. If you’re running a corporation, you’ll be issuing shares of stock, establishing bylaws, and holding shareholder meetings. Regardless of what form your business takes, you’ll want to do the following:
- Maintain a strict separation of business and personal funds and assets. Don’t use a business vehicle for personal travel, for instance.
- Recognize and follow the required business formalities.
- Keep detailed and accurate business records.
- Consult with a business professional, in particular one with experience handling business tax issues.
- Promptly respond to any IRS tax collection matters. If you avoid an unpaid tax case from escalating to a tax enforcement action, then you don’t need to worry about the IRS targeting any assets, with or without the presence of an alter ego situation.
How the IRS Will Treat Business Assets If You Have a Personal Tax Debt
If the IRS can’t show that your business is your alter ego (or vice versa), they won’t be able to go after your business property when trying to collect your personal tax debt. Even if you have the authority to access the funds in a business bank account, unless the alter ego doctrine applies, the IRS can’t place a bank levy on that business account.
All that being said, the IRS can still target payments your business owes you, such as paychecks or profit distributions. In these situations, the IRS sends a Notice of Levy to your business informing it to divert some of the money from you to the IRS. A prime example of this is a wage levy.
Is the IRS Targeting Your Business? The W Tax Group Can Help
If the IRS has targeted your business’s property to collect a personal tax debt, you need to talk to a tax professional as soon as you can. Not only can they push back against improper tax levies, but they can also negotiate a tax settlement to stop IRS tax collection actions, as well as defend against IRS alter ego claims. Use our online contact form to schedule a free consultation to learn more.
Business Assets at Risk for Personal Tax Debts FAQs
Can the IRS take money from my LLC or corporate bank account if I have a personal tax debt?
Yes, but only if the IRS feels a reverse piercing of the corporate veil is warranted.
What’s the difference between the alter ego doctrine and piercing the corporate veil?
The alter ego doctrine refers to the IRS treating an individual and their alter ego (such as a business) as a single taxpayer for tax collection purposes. Piercing the corporate veil refers to the IRS ignoring the limited liability protections offered by a business as a result of the alter ego doctrine so that the IRS can go after an individual taxpayer’s personal assets for the tax debts of the business.
How can I protect my business’s assets if I owe money to the IRS for personal tax debts?
As long as you haven’t done anything to invoke the alter ego doctrine, your business’s assets are probably safe from the IRS. The best way to not invoke the alter ego doctrine is to avoid doing anything that might lead to an alter ego situation, such as commingling of personal and business finances, business undercapitalization, and failure to observe corporate formalities.
Sources
https://www.irs.gov/irm/part5/irm_05-017-014#idm139921008282176 https://www.irs.gov/irm/part5/irm_05-017-002#idm140249336258464 https://www.irs.gov/businesses/small-businesses-self-employed/business-structures https://www.irs.gov/irm/part5/irm_05-001-021
