One of the key reasons behind forming a corporation is to shield the personal assets of the shareholders from the debts and actions of the corporation. However, this is not an automatic protection. If you are a small business there are many pitfalls to observe, otherwise, you will still be held liable, even in the event of bankruptcy of your small business. What are they?
There is a legal term “Piercing the Corporate Veil”, which exposes you to liability. You will be held personally liable to pay all the debts of your company. Although, this may apply to any corporation, piercing the corporate veil typically is most effective with smaller privately held business entities (closed corporations) in which the corporation has a small number of shareholders, limited assets, and recognition of separateness of the corporation from its shareholders would promote fraud or an inequitable result.
There is a long list of factors that courts often consider; however, a few are common pitfalls that small businesses tend to fall into.
Commingling of personal and corporate assets: If you pay for your BMW lease with company checks, or if you transfer funds between your personal and company bank accounts without signing loan agreements or promissory notes, then most likely you have violated this factor.
Undercapitalization of the C Corporation: Many small business owners set up very small equity, and take out most of the corporate earnings in terms of salaries or dividends. If courts find that your business is insufficiently capitalized compared to industry standards, you face the risk of personal liability in the event of bankruptcy.
Failure to observe corporate formalities in terms of behavior and documentation: Do you keep corporate minutes? Do you conduct shareholder meetings? Regardless of how small your company is, courts may still consider violating this standard as a basis to get to your personal assets.
Regardless how tempting it is to shift as many personal expenses to your company, even if you get through the IRS, you may fall victim to the “Piercing of Corporate Veil” when trying to protect your personal assets from the liabilities of your corporation. Remember that simply paying the fee to register your company as a C Corporation does not automatically protect you from liability. It is best to seek professional advice if you suspect your personal assets may not be shielded.
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