Taxes in your practice: 2nd Circuit finds spouse liable as S corporation shareholder following divorce, bankruptcy

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The 2nd Circuit U.S. Court of Appeals recently affirmed a U.S. Tax Court decision rejecting a taxpayer’s claim that she was no longer an S corporation shareholder following divorce and bankruptcy proceedings. This decision is a reminder to Missouri lawyers that it’s important to ensure clients clearly document ownership transitions in the context of divorce and bankruptcy to avoid liabilities. 

In Veeraswamy v. Commissioner,¹ the 2nd Circuit agreed with the tax court’s 2024 decision,² holding that the taxpayer was a shareholder for the year in question and was liable for income tax on her share of the S corporation’s capital gain and rental income. The 2nd Circuit also affirmed calculations of the taxpayer’s income and the imposition of penalties. 

Background 

The taxpayer, Karen Veeraswamy, and her husband Velappan Veeraswamy formed Ashand Enterprises, Inc. in 2000 and elected S corporation status for pass-through tax treatment to the shareholders. Upon formation, the Veeraswamys each owned 50% of Ashand per the articles of incorporation and initial board meeting. Ashand’s 2010 tax return similarly treated each of them as a 50% shareholder. 

Ashand was an investment enterprise, initially trading technology stocks and then, beginning in 2005, primarily owning and operating a multitenant building in the Bronx. Velappan Veeraswamy was Ashand’s president and ran the business. Karen Veeraswamy was listed as the secretary and treasurer of the business, and she opened bank accounts, worked in the office, and helped collect rent from tenants. 

The tax court described the marriage as beginning to fail as early as 2004 with an eventual divorce filing in 2011. During this time, Karen Veeraswamy continued to help with Ashand’s books, but Velappan Veeraswamy removed her from bank accounts and limited her access to the business office. During the divorce litigation, Velappan Veeraswamy argued that Karen Veeraswamy was no longer involved with the company, and she began filing her tax returns as married filing separately. 

All this turmoil ultimately led to a Chapter 11 bankruptcy filing for Ashand in 2013. Velappan Veeraswamy maintained in the bankruptcy that he was Ashand’s president and sole owner. Karen Veeraswamy made claims for child support and as a creditor of Ashand, but she did not claim to be a co-owner at that time. 

In 2014, a trustee sold the Bronx property for $7.6 million, leaving nearly $2 million in surplus after expenses which the bankruptcy court directed to escrow for resolution of the divorce proceedings. 

Velappan Veeraswamy then filed a personal Chapter 13 bankruptcy in 2018 which was converted to Chapter 7 liquidation later that year on Karen Veeraswamy’s motion. 

The IRS commissioner filed claims for Velappan Veeraswamy’s income tax liabilities for 2012-2015, and Karen Veeraswamy filed claims for unpaid domestic support. 

In February 2019, Velappan Veeraswamy had a heart attack and died, making the pending divorce case moot, and Karen Veeraswamy was appointed administrator of her late husband’s estate. As Karen Veeraswamy worked through Velappan Veeraswamy’s affairs, she discovered documents showing she had remained a 50% shareholder in Ashand despite Velappan Veeraswamy’s representations to courts and creditors to the contrary. 

Following Velappan Veeraswamy’s death, the bankruptcies of Ashand and Velappan Veeraswamy converged with the divorce proceedings. With the new ownership information, Karen Veeraswamy amended her claims to the Ashand surplus funds to claim an equity distribution as a 50% owner of Ashand. 

Over government objections, Karen Veeraswamy ultimately received priority payments of $486,038 on her equity claim and $480,000 in domestic support. Karen Veeraswamy did not report these items on her 2022 tax return, and she did not file a return for her 2014 tax year. The government received only a partial payment of its secured claims and nothing for its general unsecured claims. 

As this litigation was proceeding, the commissioner had also audited Ashand’s 2014 tax year, for which a return had not been filed. The commissioner reopened this audit in 2022 based on Karen Veeraswamy’s new claim that she owned 50% of Ashand. Based on information in the bankruptcy filings, the commissioner determined that Ashand realized a $1.9 million capital gain in 2014 from sale of the building, and half of the gain was attributed to Karen Veeraswamy. 

The commissioner then prepared a substitute return for Karen Veeraswamy for 2014 since she had not previously filed. This return was prepared with a bank deposit analysis and information from the bankruptcy proceedings as well as Karen Veeraswamy’s share of the 2014 Ashand capital gain. 

Karen Veeraswamy filed a petition in the U.S. Tax Court challenging the finding that she was a 50% shareholder of Ashand in 2014. 

2nd Circuit decision 

The main question addressed by the tax court and 2nd Circuit was whether Karen Veeraswamy was a 50% owner of Ashand in 2014. 

The 2nd Circuit reviewed the tax court’s legal conclusions de novo and its factual findings for clear error. The 2nd Circuit found no error with the tax court determination that Karen Veeraswamy was a part owner of Ashand in 2014.³ The court noted the initial documentation of Karen Veeraswamy’s ownership in 2000, her testimony that she participated in the business even after the parties separated, and the 2010 Ashand tax return showing her as a 50% owner. 

The 2nd Circuit found that Karen Veeraswamy failed to demonstrate that she had abandoned her ownership interest prior to 2014, and the court noted her assertions in the bankruptcy proceedings that she was a 50% equity shareholder entitled to escrow funds.⁴ 

The court also rejected Karen Veeraswamy’s argument that some language in the bankruptcy confirmation plan referring to Velappan Veeraswamy as the owner of Ashand precluded the tax court and 2nd Circuit from reaching a contrary conclusion.⁵ On this point, the 2nd Circuit found that the bankruptcy proceedings did not litigate and reach a final judgment on the merits regarding Karen Veeraswamy’s ownership. Although the plan did refer to Velappan Veeraswamy as owner, the decree closing Ashand’s bankruptcy proceeding expressly disclaimed issues relating to payments between Ashand’s equity holders or parties in interest and referenced both Karen Veeraswamy and Velappan Veeraswamy. 

Based on these facts, the 2nd Circuit found that the tax court did not err in allowing the IRS to argue that Karen Veeraswamy was an owner of Ashand. 

Karen Veeraswamy also asserted that the tax court had inaccurately calculated her income, erred in the final computations, and improperly assessed penalties. The 2nd Circuit rejected these assertions, finding that the tax court properly accepted the commissioner’s calculation of income and properly computed her tax liability.⁶ The 2nd Circuit also found that the tax court did not err in finding that Karen Veeraswamy failed to establish reasonable cause to abate penalties. 

Conclusion

The U.S. Tax Court and 2nd Circuit Veeraswamy cases were admittedly pursued by a pro se taxpayer, but the decisions demonstrate the need for lawyers to ensure there is documentation regarding ownership transitions during divorces and bankruptcies. Absent clear documentation of abandonment or ownership transfer, the taxpayer in Veeraswamy was held liable for pass-through tax liabilities from an S corporation controlled by a separated spouse and business partner. 

Veeraswamy is also notable for the IRS strategy here; an audit was initiated to protect the government tax interests outside of the pending divorce and bankruptcy proceedings.

Endnotes 
1 2026 PTC 27 (2d Cir. 2026). 
2 Veeraswamy v. Commissioner, T.C. Memo. 2024-83 (2024). 
3 2026 PTC 27 (2d Cir. 2026). 
4 Id. 
5 Id. 
6 Id.