Neglect liability? Be ready to pay up

True or false: Once an entrepreneur incorporates her business she no longer has any personal liability.
The answer may surprise you: false.

By Eric Farr
Brigham Young University

It is a great idea for entrepreneurs to create a limited liability company or to incorporate their businesses so that they avoid personal
liability if for some reason the company fails. However, it is essential for an entrepreneur to remember that there are a few cases in which a
court can "pierce the corporate veil" and rule that the owners of a corporation can indeed be personally responsible for company liabilities.
While the courts judge each case individually, ensuring that your corporation is following a few important practices will help limit the risks
of exposing yourself to personal liability.
First, you must observe corporate formalities. You should hold annual shareholder or board meetings, and you need to maintain accurate
minutes of these and other director meetings.
Second, you must act responsibly with regards to the corporate finances. You cannot continue to incur corporate debt when the company
is already insolvent, or to contract with vendors or customers without the intention of fulfilling the contract. You also need to ensure that
shareholders of the company are not endangering the corporation’s financial stability by removing unreasonable amounts of money from the
business.
Third, you cannot commingle corporate money and activities with those of any of the individuals who are in control of the organization.
Also, the corporation cannot act as a facade for the activities of the primary shareholder; and the corporation should have its own business,
assets and purpose.
Finally — and I assume this goes without saying — any criminal charge brought against the corporation can likely be brought against the
officers and directors of the business.
While the above list is not meant to be exhaustive, it will give you a good idea of
what things you should and should not be doing. Courts are finding an ever-expanding
list of reasons to hold officers, directors and shareholders of companies personally
responsible. In general, you should try, as a decisionmaker of a corporation, to avoid
conflicts of interest that may put creditors, customers, vendors and other stakeholders
at a disadvantage.
You may notice that I have not yet mentioned the Internal Revenue Service.
Interestingly, the IRS has no need to get a court ruling to pierce the veil. Under federal
law, directors and officers can be held personally responsible for tax liabilities including
income and payroll taxes.
The IRS is specifically concerned about companies that withhold income tax for
employees and then use those funds for anything other than paying taxes. Ultimately,
these monies are employees’ earned income and are not owned by the corporation,
and thus should never be used for anything other than paying the employees’ tax
liabilities. As you can imagine, if you are found to be misusing tax withholding funds,
the IRS acts swiftly and the penalty can be extremely harsh. More information can be
found at the IRS Web site.
Unlike a sole proprietorship, an LLC or corporation can ensure that creditors of a
company only have claim on the assets of the business and can keep creditors away
from any personal assets of the entrepreneur.
However, it is essential that the above practices be followed. If you think you might have some personal exposure to corporate liabilities,
then I suggest getting professional advice immediately.

Eric Farr is a graduate of The Wharton School and of Brigham Young University, where he participated in the student club sponsored by the
Center for Entrepreneurship. He can be reached via e-mail at [email protected].

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