Business owners need to demonstrate good business practices in order to reduce their company’s liability and to prevent personal liability themselves. Operating a business through an LLC or corporation won’t protect your home and personal property from business lawsuits and creditors if you don’t also demonstrate good business practices. The following are some of our recommendations:
Maintain the corporate or LLC veil of protection. Even corporations and LLCs that were properly formed could end up losing their asset protection quality if on-going compliance isn’t maintained. The corporate or LLC structure must be respected as separate from its owners. Certain decisions made by its directors must be recorded in its minutes; annual filings must be done and many more formalities must be maintained.
Carry adequate insurance for your company. Insurance is a way for a company to transfer a large part of its risk to an insurer to prevent the full impact of an uninsured loss, which could threaten its viability. The law requires that companies act responsibly and be adequately protected with the right kinds of coverage to manage the risks common to their industry and other areas of vulnerability. Not having adequate insurance is one of the surest ways to have your corporate or LLC veil pierced.
Avoid alter ego issues. Committing alter ego blunders may cause your company’s wall of protection to be disregarded by the court, because the law can’t see a difference between you and the company. The IRS often uses alter ego doctrine to deny tax deductions, re-characterize corporations into less favorable tax structures and eliminate pretax fringe benefits for business owners and their families. (See our article: “Alter Ego Blunders—Piercing the Corporate Veil” for more details).
Avoid uneven distributions to shareholders. S corporations must distribute profits to shareholders based on their percentage of ownership. When uneven distributions are made, the creation of a second class of stock may have inadvertently disqualified the S election. This could cause the corporate structure to be disregarded (losing its asset protection quality) or only invalidating the S election (converting the company to a C corporation) causing double taxation of shareholder distributions.
Pay attention to employment matters if you have employees. Be sure to understand the labor laws pertaining to hiring practices, wage and hour violations, discrimination, harassment, wrongful termination and more. Employment lawsuits are among the most expensive faced by small businesses. It’s wise to have an Employment Manual (even if not required) in which each employee signs an acknowledgment of company policies. Employees should be informed as to their job descriptions; what is expected of them; business appropriate behavior; social media policies and other details of the manual.
Protect customer data. When collecting customer data, the laws holds that you have a fiduciary duty to protect that data the best you can. Hackers attack more small companies looking for personal data because they have less security than the big ones. You may also want to insure yourself against this type of breach.
Don’t violate intellectual property laws. With the rapid increase in websites and social media usage, companies today need to understand how intellectual property laws work. You wouldn’t want to post something that others have written or link to an article or news story to find out you violated copyright laws. When creating a company logo or branding your company, be sure to verify that the name or symbol is available to prevent an infringement lawsuit.
Protect your trade secrets. When hiring someone to produce something for you, be sure that the employment contract includes nondisclosure language to protect your company’s trade secrets and that the contract spells out emphatically that work for hire is owned by you and not the contractor or employee you hired to produce it.
Pay the company’s payroll taxes. Business owners may incur personal liability for payroll taxes by choosing to pay other company obligations instead of payroll taxes. Penalties can be assessed against any responsible officer (including employees) who made the decision. The IRS has ten years to collect and will file a federal tax lien that encumbers all property owned by the responsible person, which isn’t dischargeable in bankruptcy. If all of the company’s bills can’t be paid—at least pay the payroll taxes.
Avoid co-signing or personally guaranteeing business debt if you can help it. LLCs and Corporations do not protect owners from personally guaranteeing debt.
Don’t do stupid things. One of the easiest ways for the law to pierce your LLC or corporate veil of protection is for you to commit malpractice, professional negligence or act fraudulently. Your insurance policies don’t typically cover for stupid acts either.