One of the biggest advantages of the limited liability company is the personal asset protection its owners receive from the LLC business entity.
This limited liability protection is also known as the corporate veil, and it’s the main reason for the LLC’s soaring popularity in the American business landscape. This protection is far from being limitless though, as there are actually some scenarios that can lead to your corporate veil being pierced, which strips your LLC’s owners of their personal asset protection.
We get quite a few questions from our readers about the ins and outs of the LLC corporate veil, so in this article we’ll try to answer all of your tough questions on this topic. From the basics of what the corporate veil is to the intricacies of maintaining it, we’ll tell you everything you need to know.
What Is the LLC Corporate Veil?
The corporate veil is a term used to describe the personal asset protection provided by the limited liability company business structure.
The corporate veil is so important because it protects your personal assets from creditors if your LLC loses or settles a lawsuit. This means that your creditors can only pursue your business assets, while your car, house, and personal bank accounts are protected.
The trouble regarding the LLC corporate veil comes if your corporate veil is pierced, which is another way of saying that your personal asset protection is revoked by a court. There are several ways this can happen, but there is also quite a bit that you can do to protect your corporate veil and prevent it from ever being pierced to begin with.
What Are the Limitations of the Corporate Veil?
There are some limits to the corporate veil’s ability to protect your personal assets. Even if your corporate veil is not pierced by a court, the following items are not protected by the LLC business structure.
- Taxes: Most limited liability companies use what’s known as “pass-through” taxation, which means business income is not separately taxed on the corporate level, but instead passes through to the individual owners to claim on their own individual taxes. It’s important to keep in mind that the corporate veil does not provide any protection from tax-related obligations. If you fail to pay your taxes in full, you shouldn’t expect the corporate veil to protect your personal assets from the IRS.
- Reckless Acts: Just because you own an LLC doesn’t mean you’re protected from your own mistakes. If you commit a reckless act while conducting business with your LLC, the corporate veil will not protect you. As an example, if you’re delivering products to a customer and cause a car accident on the way, your corporate veil can’t protect your personal assets from a lawsuit.
- Personal Guarantees: Especially if you operate a single-member LLC, you will occasionally be requested to add a personal guarantee to a business contract. Sometimes it can be hard to get other businesses or individuals to enter into contracts with a single-member LLC (or a small multi-member LLC) without a personal guarantee, specifically because the guarantee waives your right to a corporate veil with that entity. This ensures that the entity you’re entering into a contract with can pursue your personal assets to recoup any investment that your business doesn’t have the assets to honor.
Why Would Your Corporate Veil Be Pierced?
Piercing the corporate veil is a matter that is taken quite seriously by American courts, and as such there is a combination of three separate conditions that must all take place in order to pierce your LLC’s veil.
If only one or two of these situations arises without the other(s), your corporate veil will remain intact. However, it’s incredibly important that you do everything you can to avoid violating these guidelines, because losing your personal asset protection can be a catastrophic event.
In order to pierce your corporate veil, a court would have to see convincing evidence of the following claims:
Your LLC Is Not a Distinct Entity
The court would first need to declare that your limited liability company is not a separate entity from you as its owner. This aspect is a bit trickier to avoid for single-member LLCs, because when there is only one owner, it can be more difficult to demonstrate that the business is indeed a separate entity, rather than an extension of you as a person.
There are several ways this can occur, most of which revolve around the mixing of personal funds with business funds. For example, if the owner of an LLC pays a rent or mortgage payment on their home with their business checking account, that would be a serious red flag.
In addition, a court might rule that the LLC and its owner are not distinct from each other if there was never an attempt to indicate their separation in the first place. This is part of why we always urge entrepreneurs to have an operating agreement for their limited liability company, even if they’re running it as a single-member entity.
The LLC Is Used In a Fraudulent Manner
The next condition of piercing the corporate veil is the limited liability company being used to commit fraudulent or otherwise wrongful acts. The most common way this can happen is if your business borrows funds that it doesn’t have the means to repay, or if the LLC is spending money it doesn’t have access to.
In short, if your LLC is used in a way that indicates your ownership doesn’t care that they’re spending money they can’t pay back, it will be considered a fraudulent endeavor.
Creditors Are Left With Unpaid Bills By the LLC
Finally, if your LLC is deemed to be a continuation of your owner’s personality, and if the LLC was used to commit fraud, there is one final step to piercing the corporate veil.
If an entity that your LLC does business with is left with unpaid bills or court settlements as a direct result of your LLC failing to pay them, your corporate veil will be pierced, and your personal asset protection revoked.
How to Protect Your Corporate Veil
While the consequences for having your corporate veil pierced can be dire, there is plenty that you can do to protect yourself from ever having to worry about it. By taking the following steps, you can protect your personal asset protection from ever being removed from your business.
Follow All Rules and Regulations for Forming an LLC
Many instances where the corporate veil is pierced by a court are direct results of mistakes made at the LLC’s inception. This can mean that the limited liability company’s formation was not completed correctly, or that the company’s articles of organization were incomplete.
The most important step you can take regarding your ongoing corporate veil protection is making sure that you include all of the information your state requests to form an LLC, and that all of it is accurate to the best of your knowledge.
If your LLC isn’t properly formed, your corporate veil is never actually intact to begin with. If you want to make sure it’s done correctly you can hire an attorney or one of the many good online LLC services.
Maintain Separation Between Business and Personal Assets
In order to have the personal asset protection afforded by the corporate veil, you need to keep your business assets strictly separated from your personal assets.
This is one of the biggest reasons we urge our readers to get separate bank accounts for your business and personal finances, and even if it wasn’t a serious compliance issue, having separate accounts makes your accounting tasks much easier.
In addition, you’ll need to keep detailed records of every transaction you make between your business funds and personal funds. For example, if you make a financial contribution to your LLC from your personal checking account, or if you transfer some of your business income to your personal savings, you should make note of it in writing so that this transaction can’t be used against your corporate veil protection in the future.
In the previous section, we mentioned keeping records of the financial contributions and distributions between your limited liability company and yourself. In this one, we’ll simply state that you should be keeping detailed records of everything that happens to your LLC.
This is one of the best ways to protect your corporate veil, because no one maintains this sort of detailed recordkeeping for their own personal life, so the mere act of keeping these records indicates that your business is a separate entity from you as a person.
Other than corporate veil concerns, you should be doing this anyway, as strict recordkeeping helps with accounting, potential disputes with customers/vendors, etc.
Keep Up With Ongoing Maintenance Filings
Most states require LLCs to file annual reports which keep the state updated regarding some of the important basic information for your company, and those reports almost always have a fee attached to them. Other states have ongoing franchise taxes which are basically a fee for the privilege of doing business in that state.
Regardless of which state you form your LLC in, it is your responsibility to find out how you’re expected to maintain your business, and to stay current on any maintenance requirements your state may have. You certainly don’t want to see your corporate veil pierced just because you forgot to send in your annual report, or failed to pay your franchise tax fee.
Provide Adequate Capital for Your LLC
Your limited liability company needs to be funded with enough money to cover its operations from the moment it’s formed, or you could run into problems with your corporate veil.
This is because your business needs to have enough funds to function at all times, or a court could claim that it is not a distinct entity from you as its owner. It’s pretty easy to claim that your business isn’t a separate entity if it doesn’t have enough funding to stand on its own.
Sign Documents With Your Company Name
One of the easiest mistakes to avoid when it comes to the corporate veil is signing your own name instead of your company’s name when entering into a contract, or signing any other form or document.
You should always sign your business name in addition to your own personal name to make it clear that you are signing the document on behalf of your business, thus further establishing that you and your business are not the same entity.
The Difficulties of Maintaining a Single-Member LLC’s Corporate Veil
In several spots throughout this article, we’ve mentioned the difficulties single-member LLCs face when trying to maintain the corporate veil, so let’s dive a little deeper on this topic before we wrap things up. There are a handful of reasons it can be tricky to maintain a single-member LLC’s corporate veil, including the following.
- Commingling Assets: If you’re operating your own one-person business, it might seem like it’s unnecessary to separate your personal and business assets. After all, it’s all your money, right? In reality, it’s just as important to avoid commingling assets as a single-member LLC owner as it is with a multi-member LLC. In short, never commingle your business and personal assets!
- Documentation: Maintaining thorough records is another aspect of single-member LLCs that can feel like an unneeded hassle, but is actually vitally important. If it ever seems like you might not need to keep such detailed records of your business operations, remember that you’re doing it for the sake of your corporate veil just as much as you’re doing it for your own benefit.
- Lack of Legal Precedent: The LLC wasn’t widely accepted as a legal business entity across all 50 states until the late 1990s. As a result, there isn’t much legal precedent for the way court systems treat LLCs, and what precedent is out there is mostly for multi-member LLCs. That means that there can be some uncertainty regarding how the courts are supposed to treat single-member LLCs, which is not exactly a positive.
The limited liability company’s corporate veil is one of the most important aspects of LLC ownership, because a properly maintained corporate veil can provide wide-reaching protections for your personal assets.
However, there are plenty of ways your veil can be pierced, which removes your company’s personal asset protection, and could cost you incredible amounts of money.
If you need ongoing reminders regarding how you can maintain your corporate veil, we recommend keeping a copy of this article close at hand. You never know when a quick reminder could save your personal assets from a business creditor!