Defining ‘Alter Ego’ and Its Application to Determine Corporate Taxability

Like many things in life and the law, context is important, including, for our purposes, the defining of “alter ego” and its application to determine taxability.
To legal scholars and practicing attorneys alike, “piercing the corporate veil” is certainly not an unfamiliar concept.
Creditors of corporate entities will, at various times, pursue the controlling shareholders to satisfy an undercapitalized corporation’s indebtedness. Following along these lines, when it comes to income taxation, it is always important to be able to identify the proper taxpayer. Alter ego concepts may aid in any such determination, i.e., determining whether a corporation that presumably realizes the income should be taxed, or whether the controlling shareholder realized the income and, therefore, should bear the tax liability.

Nominee or Alter Ego Status As Taxpayer Tool

From a tax planning perspective, it is not unusual for corporations to be utilized as nominees (an equivalent of alter ego) for individuals, partnerships or other entities, especially in connection with the financing of real estate development projects.
Historically, maximum interest rates chargeable to corporate entities far exceeded the rates that were chargeable to individuals without violating state usury laws. (Today, limited liability companies may also be charged higher rates.) A finding of usurious rates could possibly render the underlying loan unenforceable. Usury laws vary from state to state.
Because of usury laws, lenders may require that the borrowing entity be a corporation. This was all well and good from a developer’s or investor’s perspective so long as the project could be operated through a non-corporate entity, i.e., a pass-through entity such as a partnership, so the double taxation aspects of a C corporation were avoided.
Further potential deductions such as depreciation could be utilized directly by the owners, most notably allowing the owners to withdraw proceeds of a refinancing without realizing gain and thereby incurring tax.
In other words, the corporate borrower, although recognized as the borrower for purposes of state usury laws, would be treated for federal income tax purposes as the nominee or alter ego of the operating partnership, the intended taxpayer. The U.S. Supreme Court has provided the roadmap of how to establish the nominee relationship. See, Commissioner v. Bollinger, 485 U.S. 340 (1988).