Court Rejects IRS Attempt to Pierce Tile Contractor's Corporate Veil

(Parker Tax Publishing September 2020)

A district court rejected both the government's and the taxpayers' motions for summary judgment in a case involving the piercing of the taxpayers' corporate veil. However, the court did disagree with the IRS's characterization of the taxpayers' business practices as abusive and said the record didn't demonstrate fraud or deception on the part of the taxpayers. U.S. v. Fowler, 2020 PTC 245 (E.D. Ark. 2020).

Background

Paul Fowler lays tile for a living. He did business through Paul Fowler, Inc. (PFI) between 2002 and 2011. During that time, he and his wife ran a "real simple business" where Mr. Fowler laid tile and Mrs. Fowler handled the records. Jim Morris was Paul Fowler's tax preparer from 1996 until 2008. He advised Mr. Fowler to incorporate his tile business for tax purposes. Neither Morris nor anyone else told the Fowlers to separate Paul Fowler, Inc. from Paul Fowler, the individual. Paul Fowler continued to run his business out of his home and use his personal trucks and tools for PFI. This was done without any type of rental agreement between himself and the corporation. He was PFI's lone shareholder. The corporation paid its state franchise taxes, but PFI never held a board meeting or shareholder's meeting. And the Fowlers mixed business and personal expenses: they paid their mortgage, cellphone, life insurance, groceries, and some fast-food costs out of PFI bank accounts. All receipts went into the proverbial shoebox.

At the end of every year, Mrs. Fowler would go "line by line" over the bank statements, and go through all the receipts in the shoebox, separating what was what, and then giving all the information to Morris to figure out the taxes. The PFI money that paid personal expenses was classified as a draw on the corporation. Between 2002 and 2008, Morris lied to the Fowlers about what PFI owed in taxes. Morris was convicted by a jury in 2011 for many crimes, including causing others to file false tax returns. PFI, it turned out, was badly delinquent in its taxes. With the help of counsel, and a new tax preparer, the Fowlers started addressing the situation in 2009. After sorting things out with the government, the Fowlers "got rid of everything" to pay more than $75,000 in back taxes, penalties, and fees. The Fowlers stopped using PFI for their tile business sometime in 2011 and formally dissolved the corporation in 2013. They thought they were out of the woods, but the government informed them that that PFI still owed roughly $77,000 in taxes for the 2009 and 2010 tax years.

According to the government, as a matter of law, the Fowlers' loose business practices added up to abuse of the corporate form to avoid their tax obligations. The government contended that Fowler illegally abused PFI because the corporation didn't pay its income taxes, which injured the Treasury. The government sued the Fowlers, seeking to collect the back corporate taxes based on one of three theories: veil piercing based on an alter ego analysis; fraudulent transfer under Arkansas Code Sections 4-59-204 and 205; or Arkansas's trust-fund doctrine. The second two theories depend on how assets are handled in winding up PFI which is ongoing. The government and Fowler each asked a district court for summary judgment as a matter of law on whether PFI was merely Fowler's alter ego.

Analysis

The district court denied the requests for summary judgment and ordered that the case proceed to a bench trial. However, the court disagreed with the IRS's characterization of the Fowlers' business practices as abusive and said the record didn't demonstrate fraud or deception on the part of the Fowlers. The court noted that Arkansas law controls whether PFI's corporate veil should be pierced and federal law, not Arkansas law, controls the application of the statute of limitations. The court noted that the corporate veil is thick and the general rule is, as a matter of equity, a court should pierce the veil only when the corporate form has been illegally abused to the injury of a third party. Under Arkansas case law, the court stated, a piercing of the corporate veil is appropriate under one of, or a combination of, the following: (1) significant failure to observe formalities, (2) substantial undercapitalization, and (3) evasion of legal obligations.

The deep issue, as the court saw it, was how the winding up of PFI was done. This is one of those cases, the court said, that turns on a combination of all the circumstances - looseness in formalities plus possible evasion of legal obligations, through some fraud, deception, or illegality. The many shortcomings in the formalities, the court opined, were not enough alone to support a judgment. The court concluded that, whether the government can prevail on the alter ego theory depends instead on the Fowlers' purposes and actions in the wind-up, just as do the government's fraudulent-transfer and trust-fund-doctrine theories. To decide where the equity is, the court said it must discern the Fowlers' intentions and that is best done after a trial.

For a discussion of tests that courts review when determining if a corporate veil can be pierced, see Parker Tax ¶29,550.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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