Sunday, August 2, 2015

Taxpayers Request Cert to Determine Whether IRS Entitled to Special Status in Alter Ego Determination

George Orwell famously said that, "all animals are equal, but some animals are more equal than others."   A petition for writ of cert filed on July 20, 2015 challenges the 9th Circuit's ruling upholding a District Court which found that the IRS was more equal than other creditors when it came to an alter ego determination.    The case is No. 15-102, Robert A. Polittle, et al v. United States of America.

 The Polittes owned several Midas franchises in California through two corporations.   According to the Polittes, their CFO stopped paying employment taxes for one of their companies in 1998 and used his background as a CPA to conceal this fact from them.   The IRS did not detect the non-payment until 2005.    By this time, taxes of $5.3 million had accrued.   After selling all of the assets of the company, the tax debt managed to grow to $11.7 million.   The IRS then filed nominee liens against the Polittes and a second corporation which they owned.    The IRS collected about $1.7 million from sale of two condominiums owned by the Polittes and all of the assets of their other corporation.   The Polittes filed a refund suit against the IRS in U.S. District Court.

In 2012, the District Court ruled in favor of the IRS.  Its factual findings detailed how the Polittes had paid personal expenses from the defaulting corporation and had transferred monies between the two companies without following corporate formalities.   The Court followed federal common law in determining alter ego and nominee but strongly deferred to California law in applying federal common law.    The Court found that the Polittes were the nominees of their corporation by virtue of the close personal relationship and the fact that funds flowed to them without consideration and without following formalities.   With regard to alter ego, the Court found that there was unity of ownership and interest between the Polittes and their corporation.   It then stated that:
When the creditor is the United States and the debt sought to be satisfied by invocation of the alter-ego doctrine is a federal tax liability, the second general requirement, inequitable result, can be deemed satisfied.
Politte v. United States, 2012 U.S. Dist. LEXIS 38467 (S.D. Cal. 2012) at *41.   The Ninth Circuit affirmed the decision in an unpublished opinion.   Politte v. United States, 587 Fed.Appx. 406 (9th Cir. 2014).    The Ninth Circuit did not address the District Court's legal conclusion that all cases involving tax debts involved an inequitable result.  Instead, it found an inequitable result based on the fact that the company only had money to "lend" to the Polittes because it was not paying taxes and that the benefit the Polittes received was less than the value of the property that the IRS recovered.    

The Polittes have now petitioned for writ of certiorari.    One of the questions raised is:
 If applying alter-ego law to pierce the corporate veil is an appropriate exercise of the equitable powers of a federal district court, does the Internal Revenue Service stand in a special, more advantageous position than other creditors of the corporation when that power is exercised?
While the odds are against the Supreme Court accepting this case (as they are with any petition), the District Court's ruling is troubling.   The corporate form exists to allow entrepreneurs to form businesses with limited liability.   If the mere fact of common ownership is sufficient to disregard the corporate form when dealing with the IRS, then the IRS would indeed be elevated to the status of a super creditor that is more equal than other creditors.

Hat tip to Peter Califano for pointing out this decision.


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