Generally, a corporation, and not its shareholders, is liable for its own debts. Under Texas law, a court may ignore the corporate form when the corporation is the alter ego of its owners or shareholders. The alter ego principle applies when there is such unity between corporation and individual that the separateness of the corporation has ceased and holding only the corporation liable would result in injustice. The existence of an alter ego situation is determined from the dealings of the corporation and the individual, including the degree to which corporate and individual property are separate or comingled, the amount of financial interest, ownership and control the individual maintains over the corporation, and whether the corporation has been used for personal purposes.
Arthur Lothringer formed Pick-Ups, Inc. as a corporation selling and financing used pickup trucks. He was the sole officer, director, and shareholder of the corporation. Pick-Ups, Inc did not file some of its required federal corporate tax returns and the IRS prepared a substitute return assessing tax and penalties against the corporation and Mr. Lothringer.
- Mr. Lothringer was the only shareholder, officer, director, and owner of Pick-Ups.
- Mr. Lothringer exercised complete dominion and control over Pick-Ups.
- Mr. Lothringer organized Pick-Ups.
- Mr. Lothringer failed to observe certain corporate formalities, including failing to file federal income tax returns and Texas Franchise Tax Public Information Reports for various years.
- Mr. Lothringer assumed a $52,000 debt of Pick-Ups owed to an individual.
- IRS also produced evidence of multiple checks written from the Pick-Ups account to Mr. Lothringer’s wife, despite the fact that she was not an employee of Pick-Ups. Mr. Lothringer did not dispute that these funds were used for personal or household expenses but argued that they qualified as either “constructive dividends” or “a non-taxable return of capital.”
The federal district court determined that there was such unity between the corporation and Mr. Lothringer that the separateness of the corporation ceased and that holding only the corporation liable for the taxes would result in injustice.
Moral of the story is if you want to maintain separation between yourself and your closely held corporation, you must respect the formalities and separation of you and the business.