T itle 26, section 6321, of the U.S. code provides: “If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount…shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.” The broad language of the statute shows Congress meant to reach every property interest a taxpayer has, allowing the government to collect tax debts from the assets of a taxpayer’s nominee, instrumentality or alter ego. Taxpayers are allowed to reduce their tax burden by any lawful means, but may not “construct paper entities to avoid taxation when those entities are without economic substance.”
In May 1991 the IRS began to examine the estate of Sloan Allen, who died in 1987. The examination resulted in personal tax assessments of approximately $26 million against Allen’s son, David. He was the fiduciary and transferee of his father’s estate, but failed to pay estate and estate income taxes relating to his father’s assets. The IRS was unable to satisfy the full personal tax assessment against David and filed a lien against Baum-Nebraska citing the corporation as David’s nominee or alter ego.
Baum-Nebraska sold precision machinery components. Since 1977 David Allen had controlled the corporation as either its sole shareholder or through proxy agreements giving him control of all of the corporation’s voting shares.
Hydraulics Baum S.A. was incorporated in Switzerland in 1988 and maintained its business office there. David Allen, who moved to Switzerland in the early 1990s, served as the company’s president, chairman and general manager.
Hydraulics Baum entered into an agreement with Baum-Nebraska to provide all of the services required to help establish Baum-Nebraska’s presence in Europe. David Allen provided consulting services to Hydraulics Baum and to Baum-Nebraska through Hydraulics Baum.
Compensation from Baum-Nebraska was Hydraulics Baum’s only source of revenue. At David Allen’s request, Baum-Nebraska made monthly payments by wire transfer from its business bank account to Hydraulics Baum’s Swiss account, which Allen controlled. Baum-Nebraska paid Hydraulics Baum approximately $1.2 million from 1993 to 2001 for Allen’s overseas efforts. Baum-Nebraska also paid certain of Allen’s credit card bills and business expenses, some of which the IRS asserted were personal in nature.
In February 2000 David Allen incorporated a new business, Baum-Delaware; the long-time employees of Baum-Nebraska became its shareholders. Baum-Nebraska sold its assets to Baum-Delaware in exchange for a $550,000 promissory note. Immediately following the sale, at David Allen’s request, the employee-owners issued voting trusts in his favor giving him voting rights with respect to their shares. Although David lived in Switzerland, he monitored the status of the business by telephone.
Baum-Delaware made monthly payments on the $550,000 note from January 2001 to August 2002 to a Swiss account entitled “Baum Hydraulics Nebraska.” After August 2002 Baum-Delaware applied the note payments against a receivable David Allen owed Baum-Delaware for various expenses he incurred paid for by that entity.
David Allen resigned from Baum-Delaware on March 26, 2002. The voting trusts giving him control of the company were revoked April 1, 2002, returning control to the employee-owners.
Result. For the IRS. Federal courts generally look to state law to determine whether an entity is a taxpayer’s alter ego. “When an entity is without economic substance, it may be deemed to be the ‘alter ego’ of the taxpayer. Alter ego means other self—where one person or entity acts like, or for, another to the extent that they may be considered identical.”
Under Nebraska law the factors relevant to determining whether a corporation is, or becomes, a person’s alter ego such that the corporate form should be disregarded include ( i ) diversion by the shareholder of corporate funds or assets to their own or improper uses and the fact the corporation is a mere facade for the shareholder’s personal dealings and the corporation’s operations are carried on by the shareholder in disregard of the corporate entity; and ( ii ) the absence of corporate formalities, the commingling of corporate and personal funds and expenses and the family relationship between corporate officers and the taxpayer. Under Nebraska law the corporate veil can be pierced when someone seeks the assets of a corporate entity to satisfy the obligation of a controlling alter ego.
The nominee theory attempts to discern whether a taxpayer has engaged in a legal fiction, for federal tax purposes, by placing title to property in the hands of another while actually retaining all or some of the benefits of being the true owner. The nominee theory helps determine whether property should be construed as belonging to taxpayers if they treated and viewed the property as their own, in spite of the legal maneuverings employed to distinguish title. The critical factor in determining whether a nominee situation exists is whether the taxpayer exercised active or substantial control over the property.
The court saw no practical difference between the nominee and alter ego theories. It held that it was apparent that after Baum-Nebraska sold its assets to Baum-Delaware, the former’s sole purpose was to collect the promissory note payments. Allen openly abused Baum-Nebraska’s corporate form for his own purpose—to avoid personal tax liability by placing the asset sale proceeds beyond IRS reach. The court concluded Baum-Nebraska held title to its property (the $550,000 promissory note and payments thereon) as David Allen’s alter ego or nominee and that the IRS tax lien should attach to the property.
Baum Hydraulics Corporation, f/k/a Baum Corporation v. United States, US-DIST-CT (2003-2 USTC 60,467).
Prepared by Claire Y. Nash, CPA, PhD, associate professor of accounting, Christian Brothers University, Memphis, and Tina Quinn, CPA, PhD, associate professor of accounting, Arkansas State University, Jonesboro.