The limited liability company (LLC) is an extremely popular entity type, especially for small businesses. And it’s no surprise why: the LLC offers a lot of flexibility and a corporate veil.
Not sure what a corporate veil is? Don’t worry – this guide has you covered. We’ll discuss what the corporate veil is, how to maintain it, and what happens if your corporate veil is pierced.
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What Is the Corporate Veil?
A corporate veil (also known as personal asset protection, or limited liability) is a legal division between the entity itself and the entity’s owners. It is a unique feature of some formal business entities, including both LLCs and corporations.
Thanks to the corporate veil, the personal assets of the LLC’s owners are protected ― this veil means that creditors or investors cannot claim your house, car, or personal finances if your LLC defaults on a loan or another obligation.
However, the veil is not all-powerful. If your business is not completely compliant, the veil can be pierced. If this happens, the personal liability protection no longer exists.
What Happens When the Corporate Veil Is “Pierced?”
A veil is pierced when a court rules that the LLC’s actions have forfeited the owners’ personal asset protection. That’s why a non-compliant business can sometimes slip under the legal radar: only when the business is brought to court (usually by a disgruntled creditor or plaintiff) is the veil officially pierced.
The veil can be pierced under several circumstances. For one, if your LLC does not adhere to the maintenance formalities required of LLCs, you could jeopardize your veil. Thankfully, the list of formalities for an LLC is far shorter than that of a corporation.
Usually, you’ll need to submit your annual report on time, keep your licenses up to date, maintain financial records, pay any necessary taxes, and fulfill any requirements unique to your state.
The veil can also be pierced if there is no division between the finances of the LLC itself and the business’s owners. This occurs most often with small, single-member LLCs, where the bank accounts for the business are held exclusively by one person. If the owner uses the LLC’s funds for personal, private affairs (or personal funds are used for business purposes), the corporate veil can be pierced.
Understandably, the court may also rule for a veil piercing if the company commits fraud. Not every case of fraud actually traces back to the LLC’s owners (especially in big entities). That said, if the court determines that the owners are either responsible for or liable for the fraud, they can declare that your corporate veil is pierced.
Finally, a court can rule that the owners are personally liable if the LLC did not have enough starting capital to survive in the first place, or if creditors are left with bills they can’t pay as a result of the LLC’s actions. Please note that these are all factors in a court’s decision ― the severity and number of offenses will ultimately affect the decision as well.
For example, you likely won’t be held personally liable for failing to file one annual report, but if you skipped multiple annual reports and also mixed your personal and business accounts, your veil would almost certainly be compromised.
How Can I Protect My Corporate Veil?
In general, smaller LLCs (especially single-member LLCs) are more likely to lose their corporate veil, because the lower accountability and smaller staff makes them more prone to overlooking requirements. Fortunately, with intentional business practices, you can protect your corporate veil relatively easily.
There are four basic steps to keep your veil intact:
1) Follow all formalities for LLCs
Paperwork is a hassle, but it’s a vital part of opening and operating your LLC. You’ll need to find some way to remind yourself when a form is due ― this is especially important for your annual reports and business licenses.
If you have a registered agent service, there’s a good chance they’ll keep a compliance calendar for you, and some states will actually send you a reminder in the mail when your annual report is due, but otherwise you’ll need to do it yourself.
2) Maintain an accurate record of your business transactions
Keeping good financial records helps you in several ways, even if it’s not strictly required by law like it is for corporations. For example, you can present your records as evidence if you’re ever audited by the IRS.
For corporate veil purposes, single-member LLCs absolutely need to maintain comprehensive records, because even the mere act of keeping track of your business transactions creates a layer of separation between you and your business entity, which is crucial for keeping your corporate veil intact.
As for multi-member LLCs, they need accurate records to protect themselves from fraud. If you track your transactions carefully, you’ll be more likely to catch discrepancies.
3) Keep personal finances separate from business finances
Most small LLCs get into trouble because their member/owners’ personal finances are indistinguishable from the LLC’s. Fortunately, you can take a few simple steps to separate the books.
The most important one is to get a separate business bank account, and by extension, you should also get checks and credit/debit cards in the name of the LLC.
When you sign checks or agreements for your business, you’ll need to note that the business is guaranteeing the document, not you personally. You can do so by adding your title and the LLC’s name underneath the signature. For example, signing “Joe Smith” with “Owner, Best Tree Guys, LLC” underneath makes it clear that this is a business endorsement, not a personal one.
Never pay bills for the business from your personal account, or vice versa. Of course, you do need to “pay” yourself to make your work worthwhile. To give some of the profits back to yourself without mixing the books, you can send a distribution to yourself (and/or to your LLC’s other owner/members).
This “transfers” the funds from the business to your personal account in compliant fashion.
4) Start out with adequate funds
When you’re starting out, make sure you have enough capital to get the business going. Any startup entails some financial risk, but appropriate financial planning increases your chance of success, and it can also help you avoid trouble down the line.
Your LLC needs to have plenty of capital at all times, including in the startup phase. Otherwise, it’s quite easy for a court to pierce your corporate veil, as your business cannot support itself without relying on your personal assets.
A corporate veil makes forming an LLC worth your while, as it provides a valuable line of separation between your business and personal finances and assets.
One of the greatest responsibilities of any LLC owner is to maintain that veil by operating a compliant business. That way, you’ll always have the personal liability protection this business structure provides, and you’ll also have peace of mind that your own hard-earned assets are protected.
If you’re ready to get started, you can create an LLC quickly through an online service like Incfile or ZenBusiness.