When Can a Creditor Break Through Your LLC?

One of the things that I like about Corporations and LLCs is the asset protection that they give to the owners. When you operate through a business structure, generally speaking you can’t personally be sued for any debts or problems that arise in your business. But there are always exceptions to those rules. So, how could your LLC or Corporation be busted?

  1. Failure to Maintain. To stay legal and active, every Corporation and LLC needs to do certain things each year, including: maintaining a Resident Agent, filing an Annual Report (where required) and filing a Federal, State and City tax return (where required). If you miss any of these things, and don’t fix them within a certain period of time, your LLC or Corporation can be revoked, or dissolved by the state. Once that happens, your legal protection is in trouble, because a creditor can argue that your company doesn’t really exist. Now if you’ve stopped doing business, closed the doors, etc., that may not work for a creditor. But if you’re still operating, perhaps not realizing that your company isn’t technically legal anymore, you could have a problem.
  2. Alter Ego Argument. If you operate your Corporation or LLC as an extension of you personally, you could face an alter-ego claim. For example, say you get into the habit of paying some personal bills through the Company account. Or, say a client writes checks to you personally, not your business, and you deposit those checks into your personal account. Or, say you tend to withdraw all money in the company account for personal use, and re-deposit money to the company as bills are due. These are all examples of you blurring the line between you and your incorporated business. The more those lines are blurred, the more likely someone will claim that the company doesn’t really exist, other than on paper, and it’s really just you. If a creditor can successfully show that your Corporation or LLC is an alter-ego of you personally, they will probably be given the Court’s approval to sue you personally.
  3. Payroll and Other Taxes. The IRS doesn’t have to follow the same rules as other creditors. That’s because the IRS and certain other government departments are called Super-Creditors, and are given addition legal rights. One of those rights is being able to sue at a federal level, and sidestep state laws. So, even though your state law may say that as an owner of an LLC, you can’t be sued personally, that state law doesn’t apply to the IRS. They can come after you for missing income or payroll taxes, and trust me – they will.
  4. Illegal Acts. If you commit a crime using your LLC or Corporation, there’s a very good chance that you may wind up being sued personally, in addition to facing criminal charges. Liability protection DOES NOT protect you if you are knowingly using your business structure to break the law.
  5. Single-Owner LLC. There’s a lot of conflicting information out there where single-owner LLCs are concerned. Some people say they don’t provide legal protection, while others say things are fine. Who do you believe?

That answer depends largely on where your LLC is formed and doing business and what’s going on at a state level. We’ve seen a few cases where an LLC was broken – but it usually relates to taxes owed by the business, the bankruptcy of personal owners, or criminal activities of the business. Your best bet here is to check in with someone local on how your state is trending – or drop us a line for more information!

Now even though there are times when Corporation or LLC protection CAN be broken, doesn’t mean that it WILL be broken. You’re still much safer operating through a business structure than going it alone as a sole proprietorship. But it’s important to understand how your business structure functions, and to make sure that you are doing everything you can to stay legal and protected.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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