Fact checked for accuracy by Janet Berry-Johnson, CPA.
You’ll hear about the corporate veil when setting up a business entity for your entrepreneurial endeavor.
The corporate veil is one of the main reasons business owners set up a limited liability company (LLC).
Doing business in any industry opens up the possibility for risk:
- What happens if a customer sues your company?
- What are the consequences if your business partner commits fraud without your knowledge?
- What might happen to you if your product causes unintentional damage?
When using an LLC, the corporate veil protects your personal assets from becoming exposed by a customer lawsuit, for example. Your company may suffer financial damage, but you won’t risk losing your personal home or vehicles.
Creating an LLC alone doesn’t mean your corporate veil continues to protect personal assets. You must actively maintain the corporate veil. Some actions might result in a “piercing” of the corporate veil, opening you to personal liability.
In this article, you’ll learn how to maintain the corporate veil while avoiding mistakes surrounding the issue of limited liability.
What is a Corporate Veil?
The corporate veil exists to separate corporate liability from personal liability. Its protection keeps personal assets safe if a court determines that your company didn’t conduct business legally or caused harm. Protected personal assets might include:
- Bank accounts
These assets remain safe from creditors or lawsuits that target your company. Is this protection 100% foolproof? The answer is “no.” Some situations allow for a court to pierce the veil, leaving your personal assets open to liability.
Common Reasons that Might Cause your Corporate Veil to be Pierced
Piercing the corporate veil occurs when a court decides that a company acted in a way that puts the personal liability of the members or owners at risk. In this case, the court disregards the corporate structure. Without the “veil” (corporate structure) in place, personal liability protection goes away.
Here are specific reasons that could cause the piercing of the corporate veil.
Fraud, Injustice, or Wrongdoing Exists
If a court decides that your company, or a member of the LLC, committed fraud, then it may ignore the personal liability protection aspect of the LLC’s corporate structure. An example of this might include the following:
- A corporation gets served a final judgment on debt due
- The corporation shuts down its operations because it can’t pay the damages
- The same members form a new LLC with the same employees and assets
- The new company continues operating a similar business as the original company did
A court could easily decide that fraud against creditors occurred, pierce the corporate veil, and expose the owner’s personal assets for seizure.
Separation of Owner/Company Entities Isn’t Maintained
You can’t intertwine personal activities with corporate activities. A failure to do so happens if you or other LLC members use company assets for personal reasons, operate the business from individual bank accounts, or fail to complete required company formalities.
Courts may pierce the corporate veil when officers, shareholders, or owners commingle personal funds with corporate funds.
Lack of Separation Between Corporate Entities
It’s possible to see the corporate veil pierced when multiple companies operate under a parent company without proper separation.
If a parent company, for example, includes the same officers as a subsidiary controlled by the parent company, then this raises red flags. This is especially true if both companies show the same corporate information, address, and consolidated tax returns.
Additional red flags in this area may include:
- Parent and subsidiary companies share bank accounts
- Both companies operate out of the same building
- The same individual controls both companies
- The subsidiary never received capitalization
- Parent company employees perform the subsidiary’s contracts
The LLC Doesn’t Perform Corporate Formalities
Your company must perform certain corporate formalities such as:
- Holding annual meetings (only required for LLCs in some states)
- Maintaining membership or stock ledgers
- Updating by-laws, operating agreements, or articles of organization
Failing to maintain corporate formalities might open up the company’s officers to personal liability.
How to Avoid Piercing Your Corporate Veil
The best way to avoid piercing the corporate veil is to remain mindful of the previous section. Don’t commingle personal and corporate activities, commit fraud, harm others in ways that invite lawsuits, or operate shady parent/subsidiary situations.
With that said, here are specific ways to remain in compliance.
Document All Business Actions
Keep documentation of everything the business does during its operations. Document the following:
- Initial and annual meetings between members or managers
- The meeting minutes from those meetings
- All contracts entered into by the LLC
Store all records for seven years or longer.
Maintain Necessary LLC Formalities
Make sure to maintain any annual filings required by your state. Pay the necessary fees for these filings on time. You also need to hold the annual meetings, maintain a membership transfer ledger, issue membership certificates, and create and update the operating agreement.
Make Adequate Corporate Capitalization Exists
A business requires equipment and money to begin and maintain operations. You can capitalize your business in various ways such as:
- Use of member funds
- Bank business loans
- Money loaned by family or friends
The key here is to designate that capital raised went specifically to the business and not to any LLC members.
Avoid Commingling Personal and Business Assets
All company assets must remain separate from personal assets if you expect to protect the corporate veil.
Your company should obtain its own business credit card and business checking account. Don’t use those accounts to pay for personal expenses such as a member’s personal car loan or home mortgage payments. Make sure business property and equipment remain separate from personal assets.
Maintain Visible LLC Status
Create a trail that shows the company exists and operates completely independently from any individual. You’ll do this through the following methods:
- Create business cards with the company name displayed
- Sign documents, leases, and contracts in the company name
- Send invoices in the company name
- Pay all business expenses with the company credit card or checking account
If the unfortunate situation arises where your company ends up in court, then you must make it clear to a judge that the company operates completely independently from its members. You might see the corporate veil pierced if a court can’t distinguish what belongs to the owners and what pertains to the business.
What Liability the Corporate Veil Doesn’t Cover
You should understand that the corporate veil doesn’t protect you 100% in all situations. You can find your personal assets exposed even if a court hasn’t officially pierced the corporate veil.
Use Personal Guarantees Carefully
Personal asset protection becomes exposed whenever you sign off on any personal guarantees on behalf of the company.
You may need to make personal guarantees on loans or contracts if the LLC doesn’t yet have substantial assets that creditors can use as collateral. You must do so sparingly and with great thought involved. As soon as you sign on that dotted line, that creditor now has the power to come after your personal assets if you default.
Pay Your Taxes
The IRS can always pursue your personal assets if you fail to stay compliant with your tax returns. Remember that your corporate LLC tax return flows the company’s profits down onto your personal tax return. The corporate veil doesn’t exist when it comes to the Internal Revenue Service. The IRS can seize personal assets when your taxes remain delinquent for too long.
Maintain Personal Responsibility
Starting a limited liability company doesn’t allow you to act like an irresponsible human being in the name of the corporate veil. Don’t expect a court to treat you as a corporate entity, safe from personal asset seizure if you act carelessly while going about company business.
For example, it’s highly unlikely that a court will maintain that you’re not personally liable if it’s proven that you committed sexual harassment at the office.
The best way to stay out of legal trouble that exposes your personal property in a lawsuit is to conduct your business and live your life as a person of high ethical standards.
Why the Corporate Veil is Harder for Single-Member LLCs to Maintain
Usually, you can rest assured that you won’t become personally responsible for any debts, for instance, that your LLC incurs. However, some situations exist where the typical LLC rules may not apply to you as the owner of a single-member LLC. This could happen if a court rules that your single-member LLC isn’t truly separate from you.
Historically, many of the rules about the separation between personal liability and LLCs concern themselves with multi-member LLCs. Single-member LLC liability laws are relatively new in comparison to laws that exist for corporations. Corporation law existed far in advance of the limited liability company coming into existence.
Corporations require more formalities than LLCs do, which means you can’t always depend on past corporation court case rulings relating specifically to single-member LLC court proceedings.
Single-Member LLC Owners and Personal Liability
A multi-member LLC can more easily separate corporate responsibilities from its member’s personal lives. Working as the only member of an LLC makes it more difficult to prove the line between your business activities and your personal liability for debts incurred or the harm you may have caused others while operating your business.
That’s why it’s so important for you to maintain a strong separation between you and your single-member LLC. It’s easy to let LLC formalities slide when operating a business by yourself.
Don’t let yourself fall into this trap. Maintain all records well. Hold your annual meetings. Pay your state fees and file the annual or every other year renewals. Remember why you’re going through these formalities. You want to protect yourself if a lawsuit occurs, and you need to keep that corporate veil in place during any court proceedings.
Commingling personal and business assets is another common reason personal liability becomes an issue with single-member LLCs. Again, this becomes problematic with individuals running a business alone because it’s easy to become lazy with bank accounts and other assets.
All it takes is for you to make a mortgage payment on your personal home with the LLC’s bank account. That type of activity is what makes it easy for a judge to view you and your business as the same entity.
The Last Word
Many reasons exist that make it attractive to form an LLC for your business. The process helps you look more professional when dealing with customers. It helps at tax time. The structure especially helps when setting forth the responsibilities of two or more co-owners.
Obtaining corporate veil protection is also a serious consideration. Follow all the advice listed here so that you maintain separation between personal and business activities. The corporate veil may save you from financial harm in the future.
Filed under: Advice Columns