To protect your hard-earned assets, every business owner should operate in the form of a limited liability legal entity. We often hear business owners say that they don’t need a limited liability legal entity because they have insurance. If they get sued, their thought process is that the insurance company will pay for all damages. When you ask these owners how much insurance they carry, here is a quick version of such a conversation. “I have $2 million of insurance coverage.” “What happens if the claimant is awarded $3 million?” “H’mm, I never thought about that.” While no business should operate without insurance coverage, in today’s litigious society, insurance coverage is not a cure all.
We have always taken the position that the second-worse form of ownership is that of a sole proprietor. We believe that the worse form of ownership is that of a general partnership because you are not only responsible for your acts, but those of your partners.
So what type of entity should you form? Common forms of ownership include corporations, limited liability companies (LLCs), limited partnerships (LPs) and limited liability partnerships (LLPs). The ideal type of limited liability ownership may vary by state and the business owner should always first consult with an experience business attorney and an experienced CPA or enrolled agent before creating such an entity.
There is often a misperception that the mere creation of a limited liability entity protects the business owner from all claims against the business because of a perceived limited liability veil or curtain. That is not always the case.
This limited liability veil can be pierced by certain acts often referred to as “piercing the corporate veil.” One such exception is where the business owner (or an officer, manager, or employee) is personally involved in an act that results in harm or loss to a creditor of the business entity. For example, an employee is driving a business car on company basis and is found to be at fault and caused serious harm to a third party.
However, piercing the corporate veil is often far more subtle because the business owner is not vigilant in respecting the legal entity. We have often preached to a business owner that “If you do not respect your own legal entity, why do you think any judge or jury will do so?” How do business owners pierce their own corporate veil? A few examples include:
- Comingling personal and business funds. The business owner mistakenly believes that since he or she is the owner of both the business and personal funds, he can pay personal expenses using company funds. If you treat the business assets as your personal assets, why shouldn’t a claimant be able to claim your personal assets?
- When signing contracts with vendors and other third parties, if signing on behalf of the company, always sign the contact as John Doe, President of ABC Co., or Managing Member or Partner of ABC. Never sign in your name only.
- Corporations are generally required by state law to hold an annual shareholders meeting. Many corporations are formed and never hold the annual meeting.
- Maintain a minutes book for corporate annual shareholder meetings.
- Your company will likely evolve during its lifetime. New officers, partners, shareholders, DBA names, etc. should be documented in official documents of the legal entity.
- If the state where the business is formed or is operating, be sure to file all annual reports with the Department of State in those states.
- As your business grows and expands its operations beyond it home state, be sure to register with the Department of State and Department of Revenue in those other states. Failure to do so may result in your company not being recognized as a “person” in the courts in that state.
- Any comments made herein should not be construed as the rendering of legal advice. Only a licensed attorney can render legal advice. We recommend that you work closely with legal counsel on these matters.
If you want to discuss your business or personal tax planning and tax preparation concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.