When is an Owner Personally Liable for Business Obligations?

Even if an owner runs his or her business in the form of a corporation or limited liability company, the owner can be personally liable for certain obligations of the business.  For example, the owner of a corporation or LLC can be held personally liable in the following situations:

(a)        Personal Actions.  An owner can never hide from liabilities created by the owner’s personal acts or omissions.  The liability shield created by the corporation or LLC works only to protect the business owner from obligations of the entity resulting from the actions of employees or other owners.

(b)        Personal Guarantees.  Any personal liability stemming from an owner’s personal guarantee of the debt of an entity is not affected by the existence of the entity.

(c)        Responsible Persons.  If a corporation or LLC fails to pay payroll, sales or similar "trust fund" taxes, any owner who has financial duties or responsibilities with the entity may be found to be a responsible person and liable for a 100% penalty tax.

(d)        Improper Distribution.  Any owner who knowingly receives a distribution from an entity which is contrary to the entity’s organizational documents or state law is liable to the entity and/or other owners for the amount improperly received.

(e)        Contributions.  If the organizational documents of an entity require an owner to make capital contributions, the owners is personally liable to make such contribution.

(f)         Piercing the Corporate Veil.  Under the doctrine of piercing the corporate veil, owners of a corporation or LLC can be liable for entity obligations if the entity is a sham or "alter-ego” for the owners.  Courts are sometimes willing to find owners personally liable for entity obligations where the entity is undercapitalized, the owner pays personal expenses out of the entity’s bank account, or the entity does not follow the required corporate formalities like holding annual meetings and maintaining an up to date corporate record book.

(g)        Participation in Management.  While limited partners of a limited partnership generally enjoy complete liability protection, such liability protection can be lost if the limited partner participates in the management of the limited partnership.   

(h)        Fiduciary Duty.  Ohio case law has imposed a fiduciary obligation on majority owners in their treatment of minority owners.  These cases most often involve promises of continued employment. 

The foregoing is not a complete list of all situations where the owner of a corporation or LLC can be held personally liable for obligations of the entity.  But these situations are relatively common.  To minimize your risk, operate your business as a corporation or LLC, purchase a reasonable level of business insurance, avoid situations which can lead to personal liability and don’t hesitate to consult with your professional advisors.

In future blogs we will be looking at how different types of entities are formed and how different types of entities are taxed for purposes of income, payroll and self-employment taxes.

Here’s hoping you find this material helpful.  If you like what you read, pass the information and the website to a friend.  If something you read here raises a question, don’t hesitate to call.  Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING:  The Ohio Department of Taxation has announced that it is going to increase the number of businesses it audits for use tax compliance.  Use tax is similar to sales tax.  Use tax liability often arises when a business purchases taxable goods for its own use from an in-state or out-of-state vendor or over the internet without paying sales tax.  The Ohio Tax Department is offering a voluntary disclosure program which waives penalties and limits a taxpayer's liability to three years of back taxes and interest.  Give me a call if you want to know more about this program.  Jsenney@pselaw.com or 937-223-1130.