Business owners beware: The IRS can hold you responsible for your business’ liabilities

Corporations and other types of business entities usually work to protect the owners’ personal assets from liabilities of the business. Sometimes, however, the IRS can hold an owner responsible for unpaid taxes of a corporation.

Generally, the IRS is able to hold shareholders responsible for corporate tax debts if a basis exists to do so under applicable state creditor law. If the state law relating to fraudulent transfers would allow a creditor to pursue a shareholder for monies transferred to the shareholder, then the IRS is also able to do so.

In a recent case, the IRS determined that a corporation owed over $120,000,000 in taxes, penalties, and interest. Although a payment plan was agreed to, it was determined that it would take over 150 years to complete the payment program! Therefore, the IRS went after several minority shareholders who were also employees of the corporation.

As owners, the taxpayers had received dividends from the corporation. As employees they had received bonuses.

The first element of a fraudulent transfer is that the transfer not be for “reasonably equivalent value.” Importantly, dividends and other distributions to shareholders are generally never considered an exchange for equivalent value. The Tax Court found that the bonuses were paid in exchange for work performed by the shareholders, but the dividends were not in exchange for value, making the dividends subject to the IRS claim.

The second element of a fraudulent transfer is that the transferor is or becomes insolvent as a result of the transfer. The IRS experts easily showed that the corporation (which owed over $100 million plus in taxes) was insolvent. The IRS was therefore able to recover the amount of the dividends from the shareholders.