“For the want of a nail the shoe was lost,
For the want of a shoe the horse was lost,
For the want of a horse the rider was lost,
For the want of a rider the battle was lost,
For the want of a battle the kingdom was lost,
And all for the want of a horseshoe-nail.”
― Benjamin Franklin
What is It?
We often remind the owners of a closely held business organization to respect the organization’s separate legal existence – that they not treat it as their alter ego. We advise them that by doing so, the owners can maintain the benefits afforded the organization by the state law under which it was formed, whether as a corporation, an LLC, or a limited partnership.
Among the items included in the owners’ “legal to-do list” are the following: comply with the organization’s governing documents (for example, its by-laws or operating agreement); hold annual meetings of the organization’s board, shareholders, or members, as the case may be, and keep records of such meetings; maintain complete, accurate, and separate bank and other financial accounts for the organization – do not commingle its funds with the funds of other persons; in dealing with third parties, the organization must act in its own name – owners should identify the capacity in which they are acting on behalf of the organization (for example, as officers, managers, etc.) ; and maintain the organization’s “good standing.”
Generally speaking, an organization is in “good standing” when it has complied with the laws of the jurisdiction under which it was formed, including any requirements to file tax returns with, and to pay any taxes owing to, such jurisdiction.
As a result of being in good standing, the organization may, among other things, conduct business within that jurisdiction, and it may qualify to do business in other jurisdictions. In many cases, an organization’s good standing will enable it to maintain limited liability protection for its owners, to obtain a loan, to sell its business, or even to access the U.S. Tax Court, as one taxpayer recently discovered.
Taxpayer Gets Into Trouble
Corp. was formed under State’s corporate law in Year 1. In Year 2, State’s tax department suspended Corp.’s charter on account of Corp.’s failure to pay certain taxes. Notwithstanding the suspension of its charter, Corp. continued to operate its business.
Corp. failed to file various federal tax returns and to pay various federal taxes for Years 3 through 8. The IRS prepared substitute returns for the years at issue and assessed all of the taxes in question, plus penalties. In an effort to collect these unpaid tax liabilities, the IRS sent Corp. a “Final Notice of Intent to Levy and . . . Right to a Hearing.”
Corp. timely requested a collection due process hearing. After the hearing was held, the IRS closed the case and issued a notice of determination sustaining the proposed levy. Corp. timely petitioned the Tax Court to review the IRS’s determination.
In response to the petition, the IRS filed a motion with the Court to dismiss Corp.’s petition for lack of jurisdiction; specifically, the IRS argued that because Corp.’s State charter had been suspended, it lacked legal capacity to file a petition and prosecute the case.
Kicked Out of Tax Court
According to the Tax Court’s rules, the capacity of a corporation to engage in litigation in the Court “shall be determined by the law under which it was organized.” In the present case, the relevant law was that of State, and Corp. had the burden of proving all the facts necessary to establish jurisdiction in the Tax Court.
According to State’s law, the State tax department may suspend the “powers, rights[,] and privileges of a domestic taxpayer” if the corporation fails to pay “any tax, penalty, or interest, or any portion thereof, that is due and payable” at specified times. Once a corporation’s powers have been suspended, it “may not prosecute or defend an action.”
Corp.’s corporate powers were suspended in Year 2, and it supplied no evidence that it had since become current on its State tax obligations, and had thereby been restored to good standing. Rather, State confirmed that Corp.’s corporate powers “remain suspended.”
Thus, the Court found that Corp. lacked the capacity to litigate at the time it filed its petition, and granted the IRS’s motion to dismiss for lack of jurisdiction.
Don’t Make It More Difficult Than It Already Is
Operating a business is no simple matter – far from it. Among the many issues and responsibilities that a business organization and its owners have to confront, tax planning and compliance may be the most challenging.
The application of the tax laws and regulations to the unique facts and circumstances of a particular business organization is not always clear and can be quite daunting. Tax advisers may be consulted as part of a good faith effort to comply with the applicable rules.
A well-informed business will recognize that it has the burden of establishing the facts on which it is basing its legal position, and of proving the reasonableness of its interpretation and application of the relevant rules, and it will plan and prepare accordingly.
All of this comes to naught, however, if the business organization and its owners, for whatever reason, fail to maintain or restore the organization’s good standing under state law and, thereby, deny themselves the opportunity to present their case in the appropriate legal forum.