Time for your year-end corporate review. Why? For over twenty years I have represented closely held and family business and am always amazed at the lack of attention that business owners pay to their corporate documents. Even limited liability companies have minimum requirements which need to be maintained. A recent tax case highlights the need for proper documentation and serves as an example of how not to run your small business.
In Politte v. U.S., the court determined that the corporation lacked a separate identity from its shareholder (the alter ego doctrine) and engaged in a legal fiction while retaining all or some of the benefits of being the true owner (the nominee doctrine). Politte v. U.S., (DC CA, 3/21/2012) 109 AFTR 2d 2012-1454109 AFTR 2d 2012-1454). The owner operated several franchises through two separate legal entities. The owner believed that the assets of one entity would be separate from the liabilities of the other and the owner’s personal assets, which would have been the result had the owner adhered to the basic formalities of corporate law.
The facts of this case are probably familiar:
- The owner regularly assigned employees, inventories and supplies to the franchises when needed regardless of which entity they were assigned and without intercompany agreements.
- The owner held meetings of the combined staff, set salaries, wrote the operation manual (which did not distinguish between the companies) and other policy manuals, decided how to allocate shared expenses and generally oversaw the management of all the franchises as if they were owned by one entity.
- The companies shared the same management team, all under the control of the owner.
- The owner repeatedly used funds from one entity to fund the operations of the other, without written agreements, terms, or consideration. For example, one entity leased employees from the other, but there wasn’t a lease agreement or payment terms in place and the leasing company often never received payment.
- The owner used corporate funds for personal expenses, including payments for remodeling his home, paying college tuition, luxury vehicles, season tickets for games in a states the business did not operate in and family trips to Hawaii and Australia and other personal investments.
- The entities did not always pay rent to the owner, who owned the land and buildings individually and the businesses would simply pay the owner’s mortgage directly without every paying the difference between the amount mortgage and the rent, which was higher.
In this case, the court held both companies and the owner responsible for unpaid employment tax obligations, despite only one company having employees. Clearly a bad result for the owner as he is now subject to taxes, interest and penalties in addition to the accounting and attorney fees and costs incurred defending himself. All of which could have been avoided by properly documenting and paying intercompany transactions, adhering to the separate corporate formalities of each entity and separating corporate and personal assets and liabilities. Taking a little time to address these issues on an annual basis can pay huge dividends and if you need assistance, do not hesitate to call me.