Successor Liability For Employment Tax Liabilities

In a recent instruction letter, Chief Counsel Advice 200847001, Chief Counsel of the Internal Revenue Service (“IRS”) was asked whether a newly formed corporation could be held liable for another corporation’s employment tax liability when the old corporation discontinued its operations and transferred its contracts and employees to the new corporation. In the case presents, a corporation organized in Puerto Rico failed to pay employment tax liabilities for over three years. The IRS filed federal tax liens against the corporation and levied on its accounts receivable. After the levy, the corporation discontinued its operations, but a new corporation was formed. The new corporation acquired all of the assets of the old corporation, retained all of the employees of the old corporation, and continued to service the old corporation’s customers. Chief Counsel was asked to opine as to whether the IRS lien attached to the new corporation’s property under successor liability theories or if the IRS had to start a new tax collection process against the new corporation.

Generally, when a business acquires the assets of another business it will not be liable for the seller’s debts and liabilities unless the buyer expressly agrees to assume them. There are exceptions to that principle. Pursuant to the doctrine of successor liability, the buyer can be held responsible for the seller’s debts if: (a) the transaction is a de facto merger of the two companies; (b) the new company is a mere continuation of the business of the old company; or (c) the transaction was fraudulent and entered into only to avoid liability.

A de facto corporate merger may exist if the two corporations have common officers and directors and share the same location, assets, employees, or business operations. A key factor in determining whether there is a de facto merger is if there was an exchange of the new corporation’s stock to the old corporation as payment for the old corporation’s assets. An exchange of stock, coupled with the continuation of business operations at the same location with the same employees and officers, supports the notion that the two corporations had merged and that the exchange of stock was payment for the merger. However, in case before the Chief Counsel, there was no payment of stock to the old corporation in connection with the transfer of assets. So, Chief Counsel looked to other theories of successor liability.

Another theory of successor liability is based on the mere continuation of the old business by the successor. In determining whether the buyer was continuing the seller’s business, a court will look to see if adequate consideration had been paid in connection with the transfer of assets. It will also consider if there are common officers or other officials who were instrumental in the asset transfer, whether the new company continued the old company’s business; and if, because of the transfer, the old company became incapable of paying its creditors. If adequate consideration was paid in connection with the sale of assets, it would appear that there is no continuation of the old business. If there are common officers or other officials who were instrumental in the transfer of assets for inadequate compensation, and if the asset transfer left the seller incapable of paying its debts, a court would deem the new company to be a mere continuation of the old company’s business. In the case before the Chief Counsel, the mere continuation of business theory was inapplicable because the identity of the corporate officers and stockholders of the new and old corporation could not be confirmed.

A buyer may also be liable for another’s debts under the alter ego theory. Under this theory, a court may “pierce the corporate veil” and find a shareholder liable for a corporation’s debt if the corporation fails to follow the formalities that would distinguish it from the shareholders. The same principle applies to other entity forms. The veil may be pierced if the business assets and those of its owner were commingled; if a business is undercapitalized; if a business did not maintain records or follow formalities such as having annual meetings, payment of dividends, and other items typically expected of a corporate entity. The alter ego theory could apply to a company that exercises control over another company’s business in such a manner that it operates as an extension of the other company. In order to find that a company is an alter ego of another, there must be evidence of ownership and exercise of control. In the case before Chief Counsel, that there was no evidence that the new company was owned and controlled by the old company or by the old one’s owners.

Another instance where a business would be liable for its seller’s debts is where the assets were fraudulently transferred to the new business. One would need to determine if the transfer of assets was part of a legitimate business transaction or if the transaction was designed to frustrate a creditor’s ability to recoup payment of debts. State laws may make certain rebuttable presumptions as to whether or not a particular transaction is made with intent to defraud. Typically, a transfer of assets made for no consideration or for nominal consideration in order to avoid paying debts would be considered a fraudulent transfer. In the example, Puerto Rican law presumes that a sale of assets for no consideration is a fraudulent transaction. Here, the IRS’s Chief Counsel found that the old corporation’s transfer of its assets to the new corporation was a fraudulent conveyance. Under the facts reported, no consideration was paid to the old corporation in exchange for its assets, and the transfer occurred after a tax lien was filed and assets were levied against the old corporation’s property. Chief Counsel found that the transfer of assets was done in order to frustrate the government’s ability to collect past due employment taxes. Therefore, the new corporation was liable for the employment taxes of the old corporation.

After the Chief Counsel concluded that successor liability attached to the new corporation, the Chief Counsel concluded that the IRS was not required to file a new assessment against the new corporation. Since a successor company steps into the place of its predecessor, and a lien has already been filed against the old corporation, no new collection action was needed and the lien against the old corporation was valid against the new corporation.