Protect Your US LLC's Liability Shield & Avoid the Risks

Like other limited liability structures, the US LLC gives you a broad liability shield that protects you and your personal assets from creditors reaching through.

That said, the very status of a "disregarded entity" LLC tempts many owners to use it like a personal wallet or a sole proprietorship. The consequences can be fatal, especially when a liability claim arises in the US.

To keep your liability protection, it is essential that you don't use the LLC as your personal petty cash. Act professionally at all times and resist the temptation to cut corners.

1What is limited liability?

As a general rule, legal entities such as LLCs protect their owners from personal liability for the company's debts. In this context, that protection is often called the "corporate veil".

Forming your business as an LLC is not enough on its own to guarantee limited liability. If a creditor of an LLC goes unpaid, the creditor can sue the owners and argue that they should be personally liable for the company's debts. This is known as piercing the corporate veil. Creditors can succeed in the following cases:

• The company is severely undercapitalized
• The company and its owners did not keep separate identities in their business affairs
• The company's actions were fraudulent or unlawful.

2How do you keep your limited liability intact?

There are a handful of guidelines every business owner should follow to keep limited liability in place:

2.1Start with enough capital

If the company never had enough capital to cover its liabilities, creditors will argue that it was not sufficiently separate from, or independent of, its owners to deserve limited liability. When you form a company, make an adequate initial investment in it to head off that claim.

2.2What does this mean for you and your business?

Money is often tight for new businesses, but every company has to estimate how much capital it reasonably needs to cover its initial costs and liabilities, including payments due to creditors and potential liabilities to third parties. If you make sure that the company's assets exceed its liabilities in the early stages, you reduce the chances of anyone successfully piercing the veil.

2.3Don't mix your finances

The company should have its own bank account and its own credit card and conduct its business separately from its owners. Individual owners should not use company money for their own purposes (for example, to pay their cable bill) without properly documenting the transaction as a loan or a distribution. If the company needs more funds and an owner wants to contribute, record it as a capital contribution, with the paperwork prepared at the time of the transaction.

2.4How do you stay compliant?

These steps help you keep a clear line between personal and business finances:

• Set up a dedicated business account and a dedicated business credit card so the company's transactions stay separate from those of its owners.
• Keep a ledger that records business expenses. A cloud accounting tool such as Xero can make bookkeeping much easier for small businesses.
• If the owners need to put in money personally, document the transaction with a written agreement between the owner and the LLC (for example, a promissory note) and a supporting resolution of the LLC approving it.

You can find more on transferring money between Europe and the USA here.

2.5Sign correctly

The company's business should be done in the company's name. Name the company as the party in every contract, and have the signer state below the signature line that they are signing for the company, for example: John Smith, as authorized member of ABC LLC, for and on behalf of ABC LLC. This shows the signer's name, the signer's authority or title, and the company the signature is given for.

2.6Why does it matter so much?

The way you sign documents on behalf of the company has to make clear that the company is separate from you as a person. If you sign a company contract on a line with your name beneath it, are you signing for the company or for yourself? Making this clear lets you show, over time, that the company is separate from you and that you are not personally responsible for its debts.

2.7How should I sign?

2.8Document the company's business

Where the LLC's operating agreement requires it, company meetings should be recorded in formal minutes and kept professionally with the company's records. Company decisions should be set out in resolutions signed by the members. These tasks are often called "corporate formalities". The word "formalities" can mislead, though, because it suggests they are optional or "just a formality". When it comes to protecting limited liability, this documentation is important and necessary.

2.9Why is this necessary?

In everyday life you don't have to document your decisions: it's enough that you know why you did something and remember it. When you form an LLC, though, you create a separate entity, a separate "self" apart from you and your mind. The company has no brain to remember how decisions were made or why, so these things have to be documented on paper. That paper trail is key to keeping the company's liability protection (limited liability) intact, because it shows that you treat the company's affairs as separate from your own.

2.10Keep your LLC in good standing

In some states, failing to file an annual report with the state of formation can lead to the automatic dissolution of your LLC. If the state dissolves your LLC, its owners lose their limited liability protection.

3Know the limits of limited liability

Even if the company and its owners keep the company's separate identity perfectly, there are still situations in which the owners can be held liable to creditors. These include:

3.1Personal guarantees

Creditors often require the owners to sign a personal guarantee for the company's obligations, for example when signing a commercial lease or a business loan agreement. Keep in mind that a personal guarantee is a voluntary agreement to be liable for the debt in question, in effect a voluntary waiver of your limited liability protection.

3.2What is a personal guarantee?

A personal guarantee is any promise by you personally to be liable for a debt or obligation of the LLC. Guarantees are sometimes included as separate clauses in contracts, or they can come as an addendum or a separate document. Read them carefully and make sure you understand them! By signing a personal guarantee, you effectively give up the protection of limited liability. That can make perfect business sense, and sometimes it is necessary to get a deal done. But weigh the decision carefully every single time it comes up.

3.3Liability for personal acts or negligence

In some situations, courts can decide that individual members are personally liable for their own acts or negligence, even though they were acting on behalf of the company, regardless of the corporate "veil". For example, if a member drives a delivery van recklessly and injures a pedestrian, that member can be held individually liable for the reckless conduct. The company can be held liable for the damage as well.

3.4Why are you personally liable?

People sometimes say business owners wear "several hats". At times you have your "owner" hat on, deciding the company's affairs. Then you make a private phone call wearing your "personal" hat. And so on. As you move through the world, driving vehicles, operating machinery, moving equipment or goods and so on, you wear both hats. In other words, you act both as a business owner and as a private individual. If you cause damage or injury, what you did while wearing both hats can be used to establish liability against your company and against you personally.

3.5Liability for taxes

Members of limited liability companies are personally liable for their own taxes arising from the company's business. They can also be personally liable for certain company taxes (for example, certain state and federal employee withholdings) if they are "responsible persons" who controlled the company's money and its ability to pay its debts.

3.6Wait, I'm personally responsible for the LLC's taxes?

Yes. If you are a "responsible person" for the company's finances, you can be personally liable, depending on the tax law involved. To protect yourself, record the company's transactions properly and pay all taxes due to the various tax authorities on time. It is not enough to simply send the payments to a payroll company without following up or making sure the payroll company does its job and pays the money to the government on your behalf. If you are responsible for the company's finances, you may be personally obligated to pay the company's taxes.

For more practical tips on the LLC, see Key facts about the US LLC and our overview of the LLC as a legal form; all our formation services are on the Formation page. The tax-free US LLC without a US permanent establishment is the specialty of our sister site zerotax.llc.

In short

• The LLC protects its owners from personal liability for the company's debts. But creditors can pierce that protection if the company is severely undercapitalized, the company and its owners don't operate separately, or there has been fraud.
• Four rules keep the protection intact: adequate starting capital, no commingling of finances, signing correctly in the company's name, and documenting your business.
• Miss the annual report in your state of formation, and in some states you risk the automatic dissolution of the LLC, and with it your liability protection.
• The protection has limits: personal guarantees, your own acts or negligence, and certain taxes you are liable for as a responsible person.

How we help you

• Form an LLCThe US LLC with a permanent establishment, turnkey in six states.
• LLC and LP Tax ReturnForm 1065 and K-1 for your LLC or LP.
• PayrollPayroll, payroll taxes and filings for your employees in the USA.
• Company formation consultationEntity type, state and tax consequences, before you commit.