The “Limits” of Limited Liability
- Published: 10/31/2011
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- Download: The “Limits” of Limited Liability
One of the reasons business owners choose to operate through a separate structure, such as an LLC or a corporation, is to obtain what is called “limited liability.” In investing terms, limited liability means that an owner or investor cannot lose more money than the amount they have invested or personally guaranteed. In legal terms, however, it can have a very different meaning. This article will discuss limited liability and share two common business practices that challenge the professional preparing the tax returns of the business and its owner(s).
To help us understand the role limited liability plays in protecting business owners, we posed the question to attorney Layne Diehl, who shared the following information:
“While there is no way that individuals can completely shelter themselves from all liability that may arise with a company, a properly structured organization can protect the personal assets of members and participants from liability arising out of the acts or omissions of the organization or from the acts or omissions of other members or participants. Organizing and operating documents such as bylaws, operating agreements, and articles should be carefully crafted so that proper indemnities are provided by the company. Insurance and capitalization are also factors, so making sure an organization is properly insured and in a sound financial position are important elements to limiting the liability of members and participants. In order to ensure the best protections possible, it is important that those desiring to shelter their assets this way seek the assistance of a licensed attorney in structuring and organizing their company.”
Obtaining limited liability may seem as simple as filling out a form. Maintaining it, however, may require following some administrative formalities owners may find time-consuming and cumbersome. According to Diehl, depending upon whet legal structure you choose, some of the formalities could include:
- Maintaining separate and accurate accounting records for the business,
- Not comingling the money, other assets, income or expenses of the business and its owners,
- The creation and maintenance of operating agreements,
- Having regular, documented owner/board meetings,
- Having all owner agreements and policy decisions in writing, even when those agreements are between the business and its single owner.
This may seem like a lot of unnecessary work, especially for the small business owner. Never-the-less, followed them may prove vital to having limited liability available when needed most.
Failure to follow strict formalities demanded by an LLC or corporation may also effect the tax treatment of many business transactions. Here are two common practices that often complicate the tax returns of such businesses and their owners.
- Personal Credit Cards: Small business owners know how difficult it can be to obtain a credit card exclusively in the name of their business. As a result, many owners use their personal credit cards to make common business purchases. Although the owner is merely getting things done, using personal credit cards to fund a separate entity forces tax professionals to wade through some thorny tax issues. For example: If the card is the owner’s card and not the businesses, can the business deduct the expenses charged to it? What about interest charged by the credit card company if the owner used it to charge both personal and business purchases? If the business has more than one owner, the “brier-patch” of thorns becomes a mine-field of complexity. Similar complexities are encountered when an owner pays business expenses out of their own pocket.
- Ownership of Assets: Another vexing scenario is encountered when the owner of an LLC or corporation fails to transfer title of certain assets to the newly-created entity. The owner’s tax professionals must determine who, if anyone, is entitled to the assets’ depreciation deduction. Like personal credit cards, multiple-owners make the tax consequences especially complex.
This article has briefly discussed limited liability and tax complications that commonly occur when a separate entity is created. Layne Diehl reminds us that any information shared in this article does not constitute legal advice and does not replace consultation with a licensed attorney. As always, the tax information provided by any article should never replace professional tax consultation. If you should have any questions regarding your business or personal taxes, please feel free to contact our office at (304) 267-2594 to speak with a tax professional.