Blog

Don’t be your company’s alter ego

One of the first steps in laying a proper foundation for your business is establishing a legal entity that protects you from being personally liable for the activities of the business. Most attorneys recommend new entrepreneurs form a limited liability corporation (LLC) which serves to do the exact thing outlined in its name – limit the liability of its owner. Larger businesses often incorporate their business to form a C corporation that generally serves to provide additional protection of the owners from personal liability. While this basic legal knowledge is pretty common to most, there are some key accounting responsibilities that must be managed in order to protect the legal protections provided for by an LLC or Corporation. In fact, failing to meet the accounting responsibilities of your business, can erode the legal protections all together.

Consider this recent court case that was appealed to and ruled on by the Fifth Circuit Court last week:

Pick-Ups, Inc. Arthur Lothringer was the sole officer, director, and shareholder of Pick-Ups, Inc., a used car business. When Pick-Ups failed to pay its taxes, the IRS sued Lothringer, his wife, and the business to collect them.

The district court found that Pick-Ups was Lothringer’s alter ego; therefore, he was liable for the $1.7 million Pick-Ups owed in taxes. To determine that Pick-Ups was Lothringer’s alter ego, the district court applied Texas law and relied on undisputed facts, including that (1) Lothringer was the sole shareholder, officer, director, and owner of Pick-Ups; (2) he exercised complete dominion and control over Pick-Ups;

(3) he failed to observe corporate formalities; (4) he loaned substantial money to Pick-Ups; and (5) he paid personal loans using the corporation’s bank account.

Pick-Ups was Lothringer’s alter ego. The Appeals Court agreed with the lower court’s finding that Pick-Ups was Lothringer’s alter ego. The Appeals Court was not persuaded by Lothringer’s argument that tax collection should be treated as a contract claim.

In short, the courts ruled that the Lothringer, owner of Pick-Ups, was personally liable for the tax debts of their company because they were the company’s alter ego. This determination was made because the owner loaned money to the business, and he paid personal expenses from the business’s account. This is a textbook case of commingling of funds. When a business owner fails to properly segregate personal and business funds, the owner becomes the “alter-ego” of the business and is therefore personally liable for the debts of the business.

This case, and the alter-ego designation, is a common issue facing business owners who do not use proper bookkeeping to segregate personal and business financial matters. One of the key steps in protecting your business is establishing a separate business bank account and ensuring your personal and business affairs are handled with due care and the appropriate corporate formalities. Connect with us to help develop “right-sized” business financial management and reporting that will protect you from becoming your company’s alter ego.