New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 17,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

How are Partnerships Taxed?

The following is a modified excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

Partnerships themselves are not actually subject to Federal income tax. Instead, they — like sole proprietorships — are pass-through entities. While the partnership itself is not taxed on its income, each of the partners will be taxed upon his or her share of the income from the partnership.

Form 1065

Form 1065 is the form used to calculate a partnership’s profit or loss. On the first page, you list the revenues for the business, list the expenses for the business, and then subtract the total expenses from the total revenues. It’s exactly what you would expect.

On the second and third pages of Form 1065 you answer several yes/no questions about the nature of the partnership. For instance, you’ll be asked whether any of the partners are not U.S. residents, whether the partnership had control of any financial accounts located outside of the U.S., and other questions of a similar nature.

Schedule K and Schedule K-1

The fourth page of Form 1065 is what’s known as Schedule K. Schedule K is used to break down the partnership’s income into different categories. For instance, ordinary business income goes on line 1, rental income goes on line 2, interest income shows up a little bit later on line 5, etc.

After filling out Schedule K, you’ll fill out a separate Schedule K-1 for each partner. On each partner’s Schedule K-1, that partner’s share of each of the different types of income is listed.

EXAMPLE: Aaron and Jake own and operate a partnership. Their partnership agreement states that they’re each entitled to exactly 50% of the partnership’s income. If, on Schedule K, the partnership shows ordinary business income of $50,000 and interest income of $200, each partner’s Schedule K-1 will reflect $25,000 of ordinary business income and $100 of interest income. This income will eventually show up on each partner’s regular income tax return (Form 1040).

What’s important to note here is that allocations from a partnership maintain their classification once they show up on the partners’ individual tax returns. This is important because some types of income are taxed differently than other types of income. For instance, long-term capital gains (gains from the sale of investments that were held for greater than one year) are taxed at a maximum tax rate of 20%, and for many investors (those in the 15% tax bracket or below) long-term capital gains are not taxed at all.

EXAMPLE: Aaron and Jake’s partnership buys shares of a stock, holds the shares for several years, and then sells them for a gain of $10,000. When Aaron’s $5,000 share of the gain shows up on his tax return, it still counts as a long-term capital gain (as opposed to counting as ordinary income). It will, therefore, be taxed at a maximum rate of 20%, even if Aaron is in a much higher tax bracket.

Similarly, deductions maintain their character when passed through from a partnership. For example, if a partnership makes a cash contribution to a qualified charitable organization, that contribution will maintain its character when it shows up on each of the partners’ personal returns. (That is, it will count as an itemized deduction, subject to all the normal limitations for charitable contributions.)

Self-Employment Tax for Partnerships

Ordinary business income from a partnership is generally subject to the self-employment tax when it is passed through to general partners. This makes sense given the rule that we just discussed about income maintaining its classification when allocated to a partner on his or her K-1.

Allocated Profit vs. Distributed Profit

One thing that surprises the owners of many partnerships when their first tax season rolls around is the fact that partners get taxed on their allocated share of the partnership’s profit, even if nothing was distributed to them.

EXAMPLE: Michelle, Kayla, and Tim start a partnership. Their partnership agreement states that profit or loss will be evenly allocated to the partners.

In the first year, their partnership makes $60,000. However, they’re sure that their business could grow quickly if they had the capital. So, they decide not to distribute any cash to the partners. Instead, they make plans to use all $60,000 to buy new production equipment next year.

Despite the fact that none of the partners actually received any cash payout, they’re each going to be taxed on $20,000 of business income (1/3 of the $60,000 total). That is, each is taxed on his or her “allocated profit” of $20,000 rather than his or her “distributed profit” of $0.

[Note: Profits and losses in a partnership are not required to be split evenly between the partners. The partners can choose to split the profit or loss in any way they choose. It just makes the math in the examples easier if we give each partner an equal share.]

In Summary

  • Like sole proprietorships, partnerships are “pass through” entities. A partnership is not subject to federal income tax. Rather, its owners are subject to Federal income tax on their share of the profit.
  • Form 1065 is used to calculate a partnership’s profit or loss.
  • Schedule K is used to break down a partnership’s income and deductions by category. Schedule K-1 is then used to show each partner’s allocated share of the various types of income and deductions.
  • Income and deductions from a partnership maintain their original classification when they are passed through to a partner. For example, long-term capital gains will be taxed at a max rate of 20%, and ordinary business income is subject to self-employment tax.
  • Partners are taxed on their allocated share of the profit, regardless of how much of the profit is actually paid out to them.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.

LLC Tax Advantages and Disadvantages

The following is an excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

As far as federal income taxes are concerned, LLCs don’t really exist. The Internal Revenue Code — the body of law that outlines all federal income taxation — treats each LLC as if it were one of the other types of entities.

Specifically, unless they have elected otherwise, single-member LLCs (LLCs with one owner) will be taxed as sole proprietorships, and multiple-member LLCs will be taxed as partnerships. Because of this tax treatment, LLCs — like sole proprietorships and partnerships — are often referred to as “pass-through” entities.”

EXAMPLE: Kali owns and operates a restaurant as a sole proprietorship. She later decides to form an LLC for her business. Because the LLC is a disregarded entity, the business will continue to be taxed as a sole proprietorship (for federal tax purposes at least).

EXAMPLE: Steve and Beth own and operate a winery. After learning about the potential dangers of unlimited liability in a partnership, they decide to form an LLC. Because the LLC is a disregarded entity, the business will continue to be treated as a partnership for federal income tax purposes.

LLCs Taxed as Corporations

Sometimes, after forming an LLC, the owner(s) of the LLC will decide that they would benefit from being taxed as a C-corporation rather than as a sole proprietorship or partnership. When this happens, the owner(s) have two options:

  1. Form a corporation and transfer all of the assets from the LLC to the corporation, or
  2. Fill out a form (Form 8832) electing corporate tax treatment.

The second option is certainly the easier and less costly of the two.

The same thing can be done should the LLC’s owner(s) decide that S-corporation taxation would be beneficial. The only difference is that a different form (Form 2553) is used to notify the IRS of the election.

Disregarded Entities

If a single-member LLC does not elect to be taxed as a corporation, it is referred to as a “disregarded entity” because its existence is disregarded entirely as far as federal income tax is concerned. (That is, the LLC and its owner are considered to be one and the same.)

State Taxation of LLCs

Again, unless an election is made otherwise, LLCs will be treated as either sole proprietorships or partnerships for federal tax purposes. However, depending upon where your business is located, state income taxes might not work the same way.

For example, some states tax LLC directly on their income rather than (or in addition to) taxing the owners on their share of the income. For instance, in California, LLCs are subject to an $800 annual tax, as well as an income-based fee if the LLC earned more than $250,000 in California that year.

EXAMPLE: Braden runs a sole proprietorship in California for his part-time video production business. He earns roughly $3,000 per year from the business, and is considering forming an LLC. However, even with an annual income of only $3,000, a California LLC would still be subject to a tax of $800, or more than one-quarter of the business’s total profit. Braden eventually decides that the benefits of forming an LLC would be outweighed by this disproportionately large tax.

Before deciding to form an LLC, it’s definitely a good idea to find out precisely how your state taxes limited liability companies. Generally, you’ll be able to find this information online without too much difficulty by searching for your state’s Department of Revenue or corresponding organization.

In Summary

  • For federal tax purposes, single-owner LLCs are treated as sole proprietorships, and multiple-owner LLCs are treated as partnerships.
  • The owners of an LLC can elect to be taxed as a corporation simply by filing a form with the IRS (Form 8832 for C-corporation tax treatment or Form 2553 for S-corporation tax treatment).
  • Some states do not tax LLCs the same way that the federal government does, so be sure to find out how your own state taxes LLCs before creating one.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.

How Are S-Corps Taxed?

The following is an excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

S-corporations, like partnerships, are pass-through entities. That is, there is no federal income tax levied at the corporate level. Instead, an S-corporation’s profit is allocated to its shareholder(s) and taxed at the shareholder level.

Tax Forms for S-Corporations

Form 1120S is the form used for an S-corporation’s annual tax return. (This makes sense, given that Form 1120 is used for a regular corporation’s annual return.) As with a partnership, Schedules K and K-1 are used to show how the business’s different types of income and deductions are allocated among the owners.

No Self-Employment Tax!

The big benefit of S-corp taxation is that S-corporation shareholders do not have to pay self-employment tax on their share of the business’s profits.

The big catch is that before there can be any profits, each owner who also works as an employee must be paid a “reasonable” amount of compensation (e.g., salary). This salary will of course be subject to Social Security and Medicare taxes to be paid half by the employee and half by the corporation. As such, the savings from paying no self-employment tax on the profits only kick in once the S-corp is earning enough that there are still profits to be paid out after paying the mandatory “reasonable compensation.”

EXAMPLE: Larissa is the sole owner of her S-corporation, an advertising agency. Her revenues from the business are $50,000 per year, and her annual expenses (not counting salary) total $10,000. Therefore, her S-corp’s profit for the year (before subtracting her own salary) is $40,000.

Larissa’s plan is to pay herself $30,000 in salary, and count the remaining $10,000 as profit, thus saving money as a result of not having to pay self-employment tax on the $10,000 profit.

Unfortunately, Larissa learns that the average advertising professional in her area earns in the $70,000 range annually. As such, she’s going to have a difficult time making the case that $30,000 is a reasonable level of compensation.

In the end, Larissa ends up setting her salary at $40,000 in order to avoid trouble with the IRS. Sadly, her S-corp’s profit (after paying her salary) ends up being $0, so she isn’t really saving any money on taxes as a result of S-corp taxation.

Determining a Reasonable Salary

So what’s a reasonable salary? This exact question is frequently the topic of debate in court cases between the IRS and business owners who are, allegedly, paying themselves an unreasonably small salary in order to save on self-employment taxes.

What makes the situation tricky is that the tax code itself does not provide any specific guidelines for what’s reasonable. That said, the following factors are frequently considered by courts when ruling on the issue:

  • The duties and responsibilities of the shareholder-employee,
  • The training and experience of the shareholder-employee,
  • The amount of time and effort devoted to the business,
  • The amount of dividends paid to shareholders (especially as compared to compensation paid to shareholder-employees),
  • The wages of the business’s non-shareholder employees, and
  • What comparable businesses pay for similar services.

One way to get a ballpark figure for reasonable salary is to visit salary.com. There you can run a search for the average salary earned by people in your profession in your geographical area.

Cost Basis in an S-Corporation

Much like owners of a partnership, shareholders of an S-corporation are taxed on their allocated share of the business’s profits — no matter whether or not those profits were actually distributed to them. But, also like an owner of a partnership, a shareholder of an S-corporation is not taxed on distributions from the business, so long as those distributions do not exceed his cost basis in the S-corp.

A shareholder’s cost basis in an S-corporation is increased by his allocated share of the business’s income and by contributions he makes to the business. His basis will be decreased by his share of the business’s losses and by distributions he receives from the business.

EXAMPLE: Austin forms an S-corporation and contributes $40,000 cash to the business. In the calendar year in which the business is formed, the business pays Austin a salary of $30,000, after which it has remaining ordinary business income of $20,000. During the year, the corporation also makes a distribution to Austin of $25,000.

When Austin forms the corporation, his cost basis in the business is $40,000 (the amount he contributed). The $20,000 ordinary business income increases his basis to $60,000, and the $25,000 distribution reduces his basis to $35,000. $35,000 is his cost basis at the end of the first year.

The $30,000 salary will be taxable to Austin as ordinary income, and it will be subject to normal payroll taxes as well. The $20,000 ordinary business income will be taxable to Austin as ordinary income, but it will not be subject to payroll taxes or self-employment tax. The $25,000 distribution will not be taxable to Austin at all, because his cost basis before the distribution was greater than $25,000.

State Taxation of S-Corporations

Of course, each state has its own rules regarding S-corp taxation. Some work like the federal income tax in which shareholders pay taxes on their share of the income. Other states tax the S-corp directly. For instance, in Illinois, S-corporations pay a 1.5% tax on the S-corp’s Illinois income. This tax is in addition to the income tax that shareholders pay on their share of the S-corp’s income.

In Summary

  • S-corporations are pass-through entities. That is, the corporation itself is not subject to federal income tax. Instead, the shareholders are taxed upon their allocated share of the income.
  • Form 1120S is the form used for an S-corp’s annual tax return.
  • Shareholders do not have to pay self-employment tax on their share of an S-corp’s profits. However, before there can be any profits, owners that work as employees for the S-corp will need to receive a “reasonable” amount of compensation.
  • S-corporation taxation is similar to partnership taxation in that owners are taxed upon their share of the business’s income, regardless of whether or not it is actually distributed to them. Also similarly, distributions from the business are not taxable so long as they are not in excess of the shareholder’s basis in the S-corporation.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.

How to Form an S-Corporation

The following is an excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

S-corporations are simply C-corporations that have elected (under Subchapter S of Chapter 1 of the Internal Revenue Code) to receive a special kind of tax treatment. As such, the only difference between an S-corporation and a C-corporation is taxation.

Electing S-Corp Taxation

Electing S-corp taxation couldn’t be any easier. All you have to do is fill out a single form (Form 2553), and your corporation will continue to be taxed as an S-corp for as long as you continue to meet the various shareholder requirements for S-Corp taxation.

Also, LLCs are allowed to elect S-corp taxation by filling out a Form 2553.

Who Can Elect S-Corp Taxation?

In order for a corporation to be eligible for S-corp taxation, it must meet all of the following requirements:

  1. It must be a domestic corporation (as opposed to a foreign one).
  2. It must have no more than 100 shareholders.
  3. The shareholders can only be individuals, estates, and tax-exempt organizations. (In other words, no corporations or partnerships as shareholders.)
  4. It can have no nonresident alien shareholders.
  5. It can have only one class of stock.
  6. It cannot be a bank or insurance company.
  7. All shareholders must consent to the election.

Effective Date of S-Corp Election

When you elect S-corporation taxation (by filing Form 2553), the election takes effect on January 1 of the following year, with a few exceptions:

  • If you file Form 2553 by March 15 of a given year, you can choose to have the election be effective as of January 1 of that year.
  • In the year your business is formed, if you file Form 2553 within the first two months and fifteen days of the business’s existence, you can choose to have the election be effective for the business’s first year.

In some circumstances, the IRS may grant “relief for a late election.” That is, they may allow your S-corp election to be effective for a given year, even if you did not file Form 2553 within the first two months and fifteen days of that year. In order to qualify for such relief:

  • The business must have been otherwise-eligible for S-corp taxation,
  • The business must have not yet filed a tax return for that year,
  • The business must file Form 2553 along with Form 1120S (the form for an S-corporation’s annual tax return) no later than six months from the date Form 1120S would have been due for that year,
  • No shareholder of the corporation can have reported his or her income for the year inconsistently with the S-corp election, and
  • The business must have “reasonable cause” for its failure to file the election on time.

Obviously the term “reasonable cause” leaves a lot of room for interpretation. The IRS tends to grant a good deal of leeway here, but your best bet is certainly to file within the first two months and fifteen days of the year if you want to be sure your election will be effective that year.

Losing S-Corp Status

If at any time your corporation or LLC no longer meets all the requirements for S-corp taxation, your S-corp election will be terminated automatically. Alternatively, your S-corp election can be terminated by choice at any time, as long as shareholders/members owning more than 50% of the shares of the business consent to the revocation.

If your S-corporation status is terminated, you will have to wait five years before making another S-corporation election, unless you get specific consent from the IRS to do so earlier.

When an S-corp election is terminated, the business will go back to being taxed how it was taxed before the election. That is, a corporation will go back to being taxed as a C-corp, a single-member LLC will go back to being taxed as a sole proprietorship (unless the LLC had elected C-corp taxation before it elected S-corp taxation), and a multiple-member LLC will go back to being taxed as a partnership (unless the LLC had elected C-corp taxation before it elected S-corp taxation).

Simple Summary

  • The only difference between an S-corp and a C-corp is the way in which they are taxed.
  • To elect S-corp taxation for a corporation or an LLC, simply fill out IRS Form 2553.
  • In order to be eligible for S-corp taxation, a corporation must meet several requirements.
  • In order for your S-corp election to be effective for a given year, you must usually file Form 2553 by March 15 of that year.
  • Your business’s S-corporation status will be automatically terminated if, at any point, it ceases to meet any of the requirements to be an S-corporation.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.

Partnership: Unlimited Liability Concerns

The following is an excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

It’s obvious that before you form a partnership with somebody, you should make sure that he or she is a person you can trust and have confidence in. What’s not necessarily as obvious is exactly how much you must trust this person before forming a partnership actually becomes a good idea.

Unlimited Liability — Even for Each Other!

Generally speaking, every partner in a partnership has unlimited liability for all of the partnership’s debts. (Note: Limited partnerships, which we’ll be discussing momentarily, work somewhat differently.) It’s very much like a sole proprietor’s unlimited liability but with one crucial difference: You’re now personally responsible for debts of the business, even if you had nothing to do with creating them.

EXAMPLE: Tom and Jennifer run a local newspaper, and their business is organized as a partnership. One week while Jennifer is on vacation, Tom reprints — without permission — an article from another newspaper. The other paper decides to sue for copyright infringement. Even though Jennifer had nothing to do with the legal infraction, she could potentially be held liable for the entire amount of the judgment. Such is the risk of being a partner in a partnership.

Of course, Jennifer might be successful if she took Tom to court to sue for the amount that she ended up paying. But she’d still be out the cost of the legal fees, not to mention the hassle involved.

Partners as Agents of the Partnership

Each partner can be held responsible not only for liabilities resulting from a lawsuit, but also for liabilities stemming from a contract signed by only one of the partners. This is due to  the fact that each partner is an “agent” of the partnership. As an agent, each partner has the legal power to bind the partnership — and thus each of the partners — to a contract.

Fortunately, there are some limitations to a partner’s power as an agent of the partnership. Most importantly, each partner can only act as an agent in affairs that are within the scope of the partnership’s business. For example, if you run a retail store that sells locally grown produce, you don’t have to worry about your partner buying a house under the name of the partnership. Given that the purchase of a house is clearly outside the scope of the business, your partner would have no power as an agent to bind the partnership to the contract.

Limited Partnerships

So far, our discussion of partnerships has been about what are known more precisely as “general partnerships.” In addition to general partnerships, there is another form of partnership known as the “limited partnership.” Generally speaking though, whenever somebody simply uses the term “partnership,” he’s referring to a general partnership.

The difference between the two structures is that, in a limited partnership, there are two types of partners: general partners and limited partners.

General partners have unlimited liability for the debts of the partnership, while limited partners do not. Limited partners (much like shareholders of a corporation) cannot lose an amount greater than their initial investment in the partnership. A limited partnership can have as many or as few of each type of partner as it wants, with the one notable exception that there must be at least one general partner.

One important rule about limited partnerships is that the limited partners cannot participate in managerial decisions or in the day-to-day operation of the partnership. If they do, they’ll lose their limited liability. Therefore, in many limited partnerships, the general partners are the original founders, and the limited partners are outside investors.

In Summary

  • In a general partnership (commonly referred to as simply a “partnership”), each partner has unlimited liability for all of the partnership’s debts.
  • Each partner, as an agent of the partnership, has the power to bind the partnership to a contract.
  • Partners do not, however, have the power to bind the partnership to contracts that are clearly outside the scope of the business.
  • In a limited partnership, limited partners have limited liability. They can only lose the amount that they initially invested. General partners in a limited partnership have unlimited liability.
  • Limited partnerships can have as many or as few limited partners as they choose, but they must have at least one general partner.
  • Limited partners cannot engage in the management or day-to-day operations of the partnership.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.

Legal Advantages to Forming a Corporation

The following is an excerpt from my book LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less.

For most legal purposes, corporations are distinct entities. In other words, corporations are treated (more or less) as if they were people. They’re allowed to own things, rent things, sue or be sued, and so on.

Limited Liability

The reasoning behind the concept of the corporation — a business legally distinct from its owners — was to allow the owners to not have to worry about being held personally liable for the debts of the business. Generally speaking, because the corporation is a separate entity, anybody wishing to bring a lawsuit against the business has to bring it against the corporation rather than against the owners personally.

This protection is in fact one of the fundamental elements of our entire economy. For example, what are the odds that anybody would have invested in Chipotle or McDonald’s if they knew that they could be held personally liable if anybody were to bring a lawsuit against the company as a result of getting sick from one of their products? And who would have bought shares of General Motors if there was a chance they’d be held personally liable for accidents caused by faulty manufacturing?

If corporations didn’t offer the protection they do, hardly anybody would invest in new companies.

Planning on Outside Investment? Plan on Incorporating.

For the above-mentioned reason, if you’re planning on securing cash from outside investors, it’s quite likely that your only option is going to be to form a corporation. (To be more specific, it’ll likely have to be a C-corporation due to S-Corporation ownership restrictions.)

Another reason that investors are more likely to invest in a corporation is that shares in a corporation can usually be sold more easily than ownership interests in any other type of business. Investors like knowing that if they want to get out, they can.

Ongoing Legal Requirements

One slight drawback to forming a corporation is that there are a few ongoing legal requirements that will take up your time. For example, whenever the directors of a corporation make a major decision, it must be recorded in a document known as a “resolution.” A resolution doesn’t have to be anything fancy or complicated. Just be aware that forming a corporation means you’re going to be in for a little more paperwork.

Also, most states require an annual meeting of the directors and shareholders of the corporation, as well as a record of what was discussed at the meeting. Of course, if you’re the only owner, this just means preparing one more document every year, as the “meeting” with yourself probably doesn’t have to be very long.

Tort of Corporate Shareholders

As with an LLC, it’s possible for the owners of a corporation to be liable as a result of torts they personally commit (e.g, negligence, fraud, etc.), even if the tort was performed in the service of the corporation.

“Piercing the Corporate Veil”

Whenever you read anything about the limited liability provided by the corporate form, you’re likely to encounter the term “piercing the corporate veil.” This term refers to the fact that, under certain circumstances, a court may decide that a corporation is not materially separate from its owners and that the plaintiff should be allowed to come after the owners for their personal assets.

Some of the things that may lead a court to pierce the corporate veil include:

  1. Fraudulent activity by the corporation or its owners,
  2. Intermingling of funds between corporate accounts and personal accounts of the owners,
  3. Disregard for corporate formalities (such as the preparation of resolutions and holding of annual shareholder meetings),
  4. Undercapitalization of the corporation (i.e., the corporation was formed without enough funding to be able to satisfy its existing and likely obligations),
  5. Absence of corporate financial records, and
  6. Anything else that would lead a court to believe that the corporation is merely a formality, and is not materially distinct from its owners.

Simple Summary

  • Generally speaking, the owners of a corporation will not be held personally liable in the case of a lawsuit against the corporation.
  • If you plan on attracting outside investors, you may have to form a C-corporation.
  • It’s possible for shareholders of a corporation to be held personally liable for torts they commit in the service of the corporation.
  • If a court decides that a corporation is not in fact distinct from its owners, the court may decide to “pierce the corporate veil,” thereby allowing a plaintiff to come after the involved shareholders’ personal assets.
  • Important steps toward preventing a court from piercing the corporate veil include: keeping your personal and corporate finances separate, keeping excellent records, following corporate formalities, and providing the corporation with sufficient funding.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less

Topics Covered in the Book:
  • The basics of sole proprietorship, partnership, LLC, S-Corp, and C-Corp taxation,
  • How to protect your personal assets from lawsuits against your business,
  • Which business structures could reduce your Federal income tax or Self-Employment tax,
  • Click here to see the full list.
Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2017 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy