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:

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.

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.

 

Brett Hersh's avatar
  • Author: Brett Hersh
  • Bio: Brett Hersh, EA, MBA, is the owner of HBS TAX & Small Business Experts. He is an Enrolled Agent (EA) with the IRS and licensed by the US Treasury Department to prepare all tax returns and represent taxpayers before the IRS for audits, collections and appeals. He is also Dave Ramsey’s ELP for Tax and Accounting, a continuing education instructor for tax professionals through Lorman Education, and a local speaker/presenter on the topics of tax and business growth. He can be reached at (304) 267-2594.