Are you a small business owner whose name is practically synonymous with the name of your company? If they are virtually one and the same, it can make a big difference for tax purposes. However, as evidenced by a new case, Risan, TC Memo 2026-78, 9/2/26, the “alter ego” theory won’t aways fly in the Tax Court.
This was good news for the taxpayer in the new case but the Tax Court also rejected a chorus of deduction claims.
Background: Individual taxpayers and corporations are taxed differently. Individuals pay tax under a graduated tax structure topping out at 37%. Conversely, C corporations currently pay tax at a flat 21% rate. In addition to the corporate tax, a “second tax” applies on the individual level when business owners receive distributions or dividends..
Similarly, individuals and corporations may claim deductions, within certain limits, on separate returns. In any event, detailed recordkeeping is required to substantiate claims.
New case: The taxpayer, a resident of California, was a music enthusiast and inventor who owned several incorporated businesses relating to software in the music industry. He was paid only a $50,000 salary from one corporation but withdrew funds for his personal credit card payments and other living expenses.
Besides his software ventures, the taxpayer owned an extensive collection of 700 to 1,000 vintage guitars. He claimed that his secretary’s boyfriend stole his guitar business records and demanded a $150,000 ransom. Since he refused to pay it, the taxpayer claimed that he had no records of costs of goods sold.
The IRS audited the taxpayer’s individual returns for 2014-2017 and corporate returns for 2016-2017. It eventually assessed multi-million-dollar deficiencies. The taxpayer then appealed to the Tax Court, alleging that he was entitled to a laundry list of deductions and other write-offs relating to his guitar collection.
Interesting point: One of the issues raised by the IRS relied on the altar ego theory that the taxpayer and the corporations should be treated as a single entity. However, California law requires two conditions for this to apply: (1) that separation of the individual and entities has ceased and (2) that adherence to a separate existence would result in fraud.
Upon examination, the Court said that the IRS had not met these requirements.
Accordingly, the IRS’ imposition of unreported income for the three tax years in question was denied. Nevertheless, the Court upheld most of the other IRS claims, including disallowances of deductions due to lack of recordkeeping and no or little existence of evidence. The taxpayer ultimately was found to owe millions in back taxes.
Lessons to be learned: Establishing singularity under the alter ego theory is generally a high bar to scale under state law. The IRS can’t pierce the corporate veil simply because a majority shareholder exercises unilateral control and commingles funds. But the absolute necessity for accurate recordkeeping by both individuals and corporations cannot be overemphasized.
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Tags: alter ego, collectors, deductions, hobby, Income Taxes, tax court, Taxes
