Business owners need to take legal steps to protect themselves from being held personally liable for the debts and actions of their business. That’s why forming corporations or limited liability companies (LLCs) is highly advantageous.
Taking the step to incorporate or organize generally protects business owners from such liability, but this doesn’t always stop the creditors from “Piercing the Corporate Veil” to pursue legal action against partners and shareholders. You set up your business to protect yourself, so what do you need to do to avoid litigious issues that put you personally in the crosshairs?
Avoid Commingling Funds
One of the surest ways to expose yourself to personal liability from the actions of your organization is to mix business with pleasure. An owner or partner should never be taking money out of company accounts for personal use nor should they be putting money in unless specific circumstances are present.
Putting Money In
If you are putting personal money into your business, it should be done so as an additional capital contribution that results in an additional ownership stake in the business, or as a loan. When you put personal money into the business in the form of a loan you must establish a promissory note that requires the loan to be paid back to you with interest.
Taking Money Out
When you take money out, it must be in the form of a paycheck or through a shareholder or owner distribution. Both of these require written consent or some form of a meeting between the owners to authorize such a distribution.
Conduct Actual Business According to Laws and Regulations
Establishing your corporation or LLC is a start. You must follow the necessary steps to incorporate or organize your business, but you must also keep up with the necessary laws and regulations throughout the life of your business.
Your corporation or LLC should carry out actual business as intended. State law requires shareholders and directors to hold at least one annual meeting and to convene on any major decisions such as large purchases, sales, investing, and borrowing. You will also have annual filing requirements for the state, finances, and other business aspects to account for.
It is necessary to conduct and document all business taking place in order to avoid personal liability. Neglecting these regulations could be considered a failure to conduct business properly and lead the courts to pierce the corporate veil.
While current LLC law in most states does not require an annual meeting of the owners (called members), we strongly recommend that these meetings are undertaken, as they will help to protect the owners from personal liability from the business.
Capitalize Your Business Sufficiently
When you start your business, you will need the necessary capital to operate the business. A failure to contribute enough capital to cover reasonably expected expenses and liabilities during the first months of the business will indicate to the court that there was never an actual plan to operate the business. Undercapitalization is a surefire way to lose personal liability protections.
Separate Yourself from a Single-Member LLC
An LLC with one owner (or both owners as spouses) will be considered a “disregarded entity” by the IRS. In order to avoid this issue, you will need to properly establish your single-member LLC, and if you are a married couple, to choose the taxation of your LLC wisely to avoid personal liability. Even then, single-member LLCs are easier to “pierce” because LLC law was created to protect partners from lawsuits – and while we sometimes may like to think so (or we may feel so), we can’t be a partner with ourselves!
If your single-member LLC is facing significant liability, it is advisable to issue a small equity interest to a close friend or family member to shift the LLC to a multi-member LLC.
Avoiding personal liability is one of the key benefits of incorporating your business. If you need help navigating these matters, contact the Law Offices of Tyler Q. Dahl.
Dahl Law Group
