State Law Determines Alter Ego Liability for Federal Tax Liens

By: Edmund Witter
St. John's Law Student
American Bankruptcy Institute Law Review Staff

Recently, in Old West Annuity and Life Ins. Co. v. Apollo Group,[1] the Eleventh Circuit held state law determined whether a court could pierce the corporate veil under an alter ego theory even though a federal tax lien was at issue.[2] In reaching its holding, the Eleventh Circuit had to decide whether the need for a uniform federal rule justified applying the federal common law standard for determining alter ego liability or if state law applied by virtue of a state’s right to define property interests of its taxpayers.[3]

The issue arose when a creditor, Old West Annuity, sought to foreclose a campground property owned by the debtor corporation, Apollo, Inc.[4] Shortly after Old West initiated the foreclosure action, Apollo filed for bankruptcy, which in turn stayed the foreclosure proceedings.[5] After the court lifted the stay, the property sold for $4.4 million.[6] Following the foreclosure, the Internal Revenue Service (IRS) intervened, claiming that its tax lien, which related to another entity, attached to the proceeds.[7] Specifically, the IRS claimed Apollo was the alter ego of All Seasons Resorts, who previously possessed the campground and owed over $10 million in delinquent taxes.[8] 

In order to attach a claim for unpaid taxes under an alter ego theory, the IRS had to show the taxpayer (All Seasons) maintained a “property interest” in the debtor’s assets.[9] State and federal law had different tests for determining an alter ego property interest, and thus, a dispute arose as to which test to apply.[10] Two Supreme Court cases cited by the Eleventh Circuit, Aquilino v. United States and Drye v. United States, held that state law delineates property rights for tax lien purposes.[11] Aquilino stated “it has long been the rule that ‘in the application of a federal revenue act, state law controls in determining the legal interest which the taxpayer had in the property.”[12] Courts must balance the state’s interest in defining property rights and the federal government’s interest in a uniform administration of the federal revenue statutes.[13] Similarly, Drye held that the IRS may attach property liens, but state law determines what property or rights to property the taxpayer possesses.[14] Finally, the Eleventh Circuit noted that the other circuits all agreed that state law, and not federal common law, applied when deciding alter ego liability.[15] Therefore, the court applied the state law accordingly.[16]

In United States v. Kimbell Foods, Inc.,[17] the Supreme Court presented the analysis for determining when state or federal common law applies.[18] Courts must assess (1) the need for a uniform national law; (2) whether state law would frustrate federal objectives; and (3) the extent federal common law would frustrate commercial expectations within the state.[19] For example, the Third Circuit applied federal common law in cases falling under section 541(d) of the Bankruptcy Code[20] and the Natural Gas Act,[21] which placed some price controls on natural gas prices.[22] That court noted that Congress intended to use the Natural Gas Act to supersede private contracts and ensure pipelines charge reasonable rates, and thus, a nationwide law was necessary in order to carry out the Natural Gas Act.[23]

While the Internal Revenue Code may also justify a use of a national program, the circuit courts have unanimously excluded the Kimbell Foods test when the IRS is seeking to attach a lien under an alter ego theory.[24]  The Eleventh Circuit’s decision indicates the IRS will be able to attach liens in bankruptcy proceedings, but will be bound by state law if it wishes to do so under an alter ego theory. Petitioners and creditors will have to look to state law to see if the IRS can intervene for unpaid taxes of an alter ego.