Piercing the Protective Corporate Veil Part 1: Factors 1-3

barrierA Corporation is a separate entity, distinct from its shareholders, officers and directors.  Similarly, other Limited liability Entities are also separate entities from their members and managers.  By forming one of the above-referenced entities, you avoid personal liability from the consequences of the entity’s actions and decisions.  However, courts have held that when a business operates as an individual’s or another entity’s “alter ego,” then the protective veil between individual and entity is pierced, imputing personal liability for the business’s wrongdoing.  When determining whether an entity is merely an alter-ego of another entity or individual, Illinois courts look at eleven factors, none of which are given more or less weight than others.  In this post, we will analyze the first three:

1) Inadequate capitalization

Historically, Illinois courts consider it inequitable to allow shareholders or members to set up sham organizations in an effort to escape personal liability.  When formed, an entity should be adequately capitalized to cover foreseeable expenses and liabilities.

2) Failure to issue stock

In the case of a corporation, if stock is not issued the appropriate time or at all, courts will give this factor some weight in determining whether to pierce the protective veil.

3) Failure to observe corporate formalities

Courts have found several instances of corporations failing to comply with corporate formalities, and thus leading to piercing of the protective veil.  For example, failing to maintain proper registration with the Illinois Secretary of State,  and failing to hold annual meetings.

This post is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on avoiding personal liability for your corporation or other limited liability entity’s actions.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.

Choice of Entity Series Part 4: LLP and LLC

Limited Liability Partnership:

  • Operates similarly to a General Partnership, except limited liability partners are insulated from most of the partnership’s liability.
  • Unless the Limited Liability Partnership opts for S Class Corporate tax status, the partnership will experience similar tax consequences that concern General Partnerships.
  • Bottom Line: A Limited Liability Partnership contains much less risk than a General Partnership because limited liability partner may be held liable for personal negligence, omissions, malpractice or misconduct, but not for those actions of other partners.

Limited Liability Company:

  • Like the corporate form, members’ liability is limited to the extent of their contributions.
  • The benefit of limited liability is illusory if the Limited Liability Company intends to borrow funds or execute a lease where the lender requires a member to personally guarantee the transaction or lease.
  • If the LLC elects for S Corporation tax status, the amount of deductible losses is limited by statute to the shareholder’s aggregate basis in stock in addition to any debt owed by the Corporation to the shareholder.
  • Limited Liability Companies may deduct a “reasonable compensation” to shareholders/employees from their income for tax purposes.
  • Shareholders receiving cash distributions from S corporations are taxed on the income of the entity as it is earned, even if it is not distributed.
  • Bottom Line: Limited Liability Company formation combines the limited liability of Corporations with the treatment of partnerships for federal income tax purposes.

This checklist is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on entity choice, filing proper documents with the state, and drafting partnership agreements.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.

Click here to visit the Formeller & Formeller LLP website.

Choice of Entity Series Part 3: Corporation

Corporation:

  • The corporate form offers simple means for raising additional capital.
  • From a legal standpoint, a Corporation is a separate legal entity from its owners, and it can be used to hold property in its own name.
  • The owners of a Corporation are shareholders; the extent of their liability is the assets that they contribute to the Corporation, even in the event of the Corporation filing for bankruptcy.
  • Requires strict adherence of many corporate formalities, necessitating greater administrative expenses than non-corporate forms.
  • Corporations may use a fiscal year instead of the calendar year for tax purposes.
  • The Corporation is double taxed, meaning that the Corporation is taxed on corporate earnings, and shareholders are taxed on income from dividends.
  • Interest paid from debts is tax deductible.
  • Equity capitalization (dividends) are subject to tax at the dividend rate.
  • Losses of the corporation are deductible at the corporate tax level, but are not passed through to individual shareholders.
  • Corporations may deduct a “reasonable compensation” to shareholders/employees from their income for tax purposes.
  • Bottom Line: The corporate form allows for the perpetual operation of business, for multiple, uncomplicated, transfers of ownership, and the issuance of stock options provides incentives for attracting and rewarding employees.

This checklist is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on entity choice, filing proper documents with the state, and drafting partnership agreements.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.

Click here to visit the Formeller & Formeller LLP website.

 

Choice of Entity Series Part 2: General Partnership

General Partnership:

  • General Partnerships are less complicated and expensive to organize and operate than Corporations.
  • From a legal standpoint, the General Partnership is a distinct entity from its owners.
  • General Partnerships encompass significantly more risk than Sole Proprietorships because each partner has unlimited liability for the obligation of the partnership, including acts of other partners and agents.
  • Partners are entitled to tax-free transfers on the contribution of cash or property to the General Partnership in exchange for a partnership interest.
  • The use of debt or equity financing will not substantively affect the taxation or operation of the partnership, however, debt will affect a partner’s individual basis in the partnership.
  • Income earned through the General Partnership is taxed at the owners’ tax rates, even if the partnership reinvests the income back into the business and makes no distributions to owners.
  • Losses generated by the partnership will be deductible on the tax returns of the partners to whom those losses are allocated.
  • Bottom Line: General Partnerships are useful for joint ventures because permanence is not necessary.

This checklist is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on entity choice, filing proper documents with the state, and drafting partnership agreements.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.

Click here to visit the Formeller & Formeller LLP website.

 

Choice of Entity Series Part 1: Sole Proprietorship

This is the first post in a four part series that will briefly explore several common entity forms.

A Sole Proprietorship is a choice of entity that is owned and run by one individual and in which there is no legal distinction between the owner and the business. Here is a simple checklist for the pros and cons of choosing to form a sole proprietorship:

  • This is the simplest form of doing business.
  • As stated above, from a legal standpoint, a Sole Proprietorship has no distinct existence from the owner of the business.
  • The Sole Proprietor is solely liable for the business’ liabilities.
  • Interest paid on any debt financing would be income tax deductible.
  • Any losses generated by the sole proprietorship are fully deductible by the individual owner.
  • There are no tax implications if the sole proprietorship ceases to conduct business.

Bottom Line: Sole Proprietorships are commonly utilized by individuals starting new businesses, especially if the businesses are operated on a part-time or limited basis.

This checklist is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on entity choice, filing proper documents with the state, and drafting organizational documents and agreements.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.

Click here to visit the Formeller & Formeller LLP website.

Disclaimer

The purpose of this blog is to deliver news and information that are relevant to our areas of practice. The news and information reported on this blog represent the legal actions of attorneys throughout the United States. Our firm does not claim to represent plaintiffs or defendants in all of the lawsuits, settlements, and jury verdicts reported, only those noted as Formeller & Formeller LLP cases. This blog is not intended to be legal advice. Before considering legal action in a business matter, you should seek counsel from an attorney.