What is Piercing the Corporate Veil, and How do I Avoid it?
A corporation is a distinct separate entity from its owners and operators. When properly operated, the corporation protects owners and operators from being liable for business debts. A poorly operated corporation can leave the owners and operators open to financial damage. Learn how to protect yourself by avoiding piercing the corporate veil.
WHAT IS THE CORPORATE VEIL?
A corporate veil is a legal term that refers to the separation of a corporation and its owners and shareholders. Think of it as an invisible veil that shields the owners and shareholders from being held personally liable for the corporation’s debts and liabilities. The corporate veil is a valuable tool for protecting personal assets.
WHAT IS PIERCING THE CORPORATE VEIL?
Piercing the corporate veil is a legal term describing an action taken by the court to remove the separation of the court and the owners and operators. In order to receive the protection of a corporate veil, the corporation must be run correctly. If the owners or operators fail to maintain the proper corporate paperwork, co-mingle funds, or commit fraud, creditors can convince a court to hold the owners and operators personally liable for the corporation’s debts.
HOW TO AVOID PIERCING THE CORPORATE VEIL
By following the legal requirements for running a corporation, owners and operators can protect themselves from becoming personally liable for business debts. Practice the following seven steps to avoid piercing the corporate veil.
1. FOLLOW FORMALITIES
Comply with the legal requirements set by your state regarding corporation formation, corporate bylaws, annual meetings, state filings, and other activities. LLCs generally are not required to hold annual meetings, but it is a wise idea to do so, because it helps establish a separation between the LLC and the owners and operators.
2. FUND THE CORPORATION PROPERLY
Fund the new corporation with enough money to reasonably acquire assets and pay for operating expenses. An improperly funded corporation can be construed as a scam, making it vulnerable to a court decision to pierce the corporate veil.
3. DOCUMENT THE CORPORATION’S ACTIVITIES AND KEEP RECORDS
Document all meetings and significant business decisions. Keep a record of all documents and contracts for seven years.
4. KEEP PERSONAL AND BUSINESS ASSETS SEPARATE
Always keep personal and business assets separate. Open separate bank accounts, credit cards, and lines of credit for the corporation. Never transfer money, or make charges on corporate accounts for personal use. Document all charges and withdrawals from corporate accounts in a ledger and hold the records for seven years.
5. FOLLOW PAYROLL REQUIREMENTS
If your corporation has employees, be sure to withhold income taxes, Social Security taxes, and Medicare taxes, and send the withheld funds to the government. Sending withheld payroll taxes to the government is more important than paying other business debts. An owner who fails to send payroll tax funds to the government can be held personally liable for the money owed.
6. AVOID PERSONALLY GUARANTEEING A BUSINESS LOAN
It is hard for a new corporation to qualify for a business loan without a personal guarantee. A personal guarantee is when the bank makes an owner or operator personally liable to repay the loan if the corporation fails to repay it. Instead, secure a business loan using the corporation’s assets as collateral. Apply for government grants that do not have to be repaid. Work on building business credit so that your corporation can obtain a loan without a personal guarantee in the future.
7. MAKE YOUR CORPORATE STATUS KNOWN
All business cards, bank accounts, contracts and documents should contain the corporation’s name. If you fail to make it know that your business is a corporation, a court may decide that the business is not a separate entity from its owners and operators.
LINKS TO RESOURCES
Corporate Bylaws Template
Free Corporate Meeting Minutes Template
National Business Association: How to Avoid Piercing the Corporate Veil
U.S. Small Business Administration: Three Ways to Lose Personal Liability Protection – And What to Do About It
DocStoc: Piercing the Corporate Veil