When you form a business, one of your main concerns should be safeguarding your personal assets. The ability to be held personally liable for the debts or lawsuits of your business is limited depending on the business entity that you elect to establish.
When you establish your business, you will choose from a range of organizations. Each entity handles the liability of owners (or “members”) differently.
A sole proprietorship is a business model that has single member ownership. Sole ownership makes determining liability a little bit clearer because there aren’t multiple members to consider.
However, a sole proprietorship is not considered a separate entity. This means that legally, there is little distinction between member and business in terms of liability. A sole proprietor remains personally liable for the debts of the business.
Establishing a sole proprietorship is a higher risk if your business runs into financial trouble, but it is a model that is easier to establish. Additionally, it is a cheaper, non-partnership method of conducting business.
A C corporation is a business that is taxed as a separate entity from the owner. However, this model of business offers members limited liability when it comes to the debts of the business.
However, income for the C corporation is “double taxed” by the IRS. When the income reaches the business, it is taxed as the income of the business. Once that income is distributed to members, it is then taxed again when filed alongside the member’s personal income taxes.
In other words, the C corporation protects against personal liability of the business’ debts, but members are liable for the additional taxation that applies as a result of this business model.
The IRS considers an S corporation “by law to be a unique entity, separate and apart from those who own it.” However, an S corporation is a business that is not taxed as a separate entity from the owner. Therefore, an S corporation bypasses the double taxation of a C corporation.
However, the business itself is considered an entity apart from the owner. Separation as a legal entity allows you retain limited personal liability for the debts of the business. Your financial responsibilities are limited by law.
You claim profits and losses on your personal income taxes, rather than filing a separate income tax on the business. However, this taxation method requires additional record keeping in order to provide business income and personal income in the case of a lawsuit.
In a partnership, each partner is a part of and responsible for the business. These responsibilities include finances, property management, business labor, and any other attributes required in order for the business to be successful.
A partnership is essentially sharing a business with those who hold joint ownership. Therefore, all profits and losses are shared with all owners. This model offers limited liability differently because the degree of liability for each partner is established collectively by the partnership.
In the partnership agreement, the partners must agree on a number of terms. Most importantly, partners must establish the division of profits, how legal disputes are handled, and how the partnership affects the business in the future (i.e. changing partnership, dissolving the partnership, etc.)
A partnership agreement is not legally required in order for a partnership to operate. However, it is recommended in order to avoid conflict in liability should legal issues arise.
Limited Liability Company (LLC)
As the name suggests, an LLC is a prominent business models for establishing limited liability. An LLC can have one or more owners, or “members,” who share the benefit of limited liability.
Your business exists as a separate legal entity. Therefore, your personal assets cannot be held to compensate for the debts of your business. This protection is equally applied to all members.
“Piercing the Corporate Veil”
The phrase “piercing the corporate veil” refers to the circumstance in which a court may deem it suitable to hold you personally liable for business debts or lawsuits. This is something that typically occurs when there are serious abuses of power, such as the intermingling of corporate and personal assets.
Business structures are formatted to prevent piercing the corporate veil unless a court finds it absolute. Intentional abuses of business protections or unsuitable business practices are common issues that risk your liability.
Keep in mind that limited liability does not equate to total exemption. Evidence of fraudulent, inadequate capital, or failing to follow corporate formalities that are established at the start of the business are examples of court considerations when pursuing personal liability.
Guarding Against Personal Liability
The safest way to guard against your personal liability for business practices is to establish a business model that offers limited liability. A limited liability company (LLC) is the best option for protecting your personal assets.
With an LLC, you are able to have single or multi-ownership of the business. Rather than having the full liability of sole proprietorship or the shared liability of a partnership, your LLC status protects you from being personally liable.
Additionally, conducting business in a lawful manner safeguards you from additional liability concerns, such as piercing the corporate veil. Establishing your limited liability business is not your only action in protecting your personal assets; you must conduct business lawfully in order to protect yourself from liability.
A preventative measure to protect you from personal liability is establishing business insurance coverage. The purpose of business insurance is to protect you from personal liability, including business losses, damages, or litigation against the business. Different forms of business insurance protect you from different liabilities, and depend on the type of business that you own.
“Piercing the Corporate Veil” Litigation
The ability to pierce the corporate veil works both ways: you can be sued for your personal liability in business, or you can sue against someone else for their personal liability.
As a business, you are able to offer your services to other existing businesses. In doing so, you risk that business declaring bankruptcy or defaulting on their payment of those services. In these cases, you have the ability to sue the business for the payment of those services.
If the company is “defunct,” or no longer in existence due to financial or legal circumstances, you have the ability to appeal to the court in order to pierce the corporate veil. In doing so, you may be able to reach the owner’s personal assets in order to ascertain your established payment.
When you are establishing your business, there are options for preemptively protecting your personal assets. Whether you opt for a limited liability business structure, enroll in business insurance, or seek to protect against piercing the corporate veil, you have a wide array of limiting your liability.
Schedule a consultation with our business law attorney in order to discuss your liability and how to protect your personal assets.