Liability of LLC Members: Everything You Need to Know
The liability of LLC members depends on a few factors. It's important to know this information when running your business.3 min read
The liability of LLC members depends on a few factors. It's important to know this information when running your business.
What is an LLC?
A limited liability company, or LLC, is a type of business entity that is separate from its owners. It is not required to pay its own taxes, unlike a corporation, as it's a pass-through tax entity. All profits and losses from the business are passed through to the owners, who then report them on their own tax returns. This is similar to a sole proprietorship or partnership's tax structure.
Some people think LLC means "limited liability corporation, " but this isn't true. An LLC is a company and is less complex and requires less paperwork to create and run than a corporation.
Similar to shareholders in a corporation, LLC owners are not responsible for the debts and claims of the business. Creditors are not allowed to come after a member of the LLC's car, house, or any other personal possessions. Only LLC assets pay off debts of the business so that the only money owners can lose is the money they invested in the company.
Exceptions to Limited Liability
However, there are some exceptions to this limited liability. An owner of an LLC can lose their protections and be found personally liable if they:
- Personally guarantee a business debt or bank loan on which the LLC defaults.
- Co-mingle the LLC's and their personal finances or blur the line between personal and company business.
- Break the law.
- Doesn't deposit taxes that are taken out of employees' wages.
The most important factor is owners not acting like the LLC is a separate business. The court can decide that the company doesn't exist and find the members are personally liable for their actions. To prevent this from happening, always act legally and fairly. Don't misrepresent or conceal facts or the state of your finances to creditors or vendors.
Make sure your LLC is adequately funded. Put enough cash in the business so all liabilities and expenses can be met in the future. It's also important to keep personal business and the LLC separate. A federal employer identification number should be obtained, a business-only checking account opened up, and personal finances should be kept in a separate accounting book. Forming an operating agreement is also necessary. Taking these steps will increase your LLC's credibility.
Additional Protection: Business Insurance
Having a solid liability insurance policy will shield personal assets in cases where limited liability protection doesn't. For example, if a massage therapist accidentally hurts a client's back, the therapist's limited liability policy should have them covered. This insurance can also protect against personal assets in case a limited liability status gets ignored by the court.
Insurance will also protect the assets of the LLC from claims and lawsuits. However, the LLC will not be protected if their bills aren't paid. Commercial insurance will not protect corporate or personal assets from business debts that are unpaid, no matter if they're personally guaranteed or not.
Overview of Corporate Limited Liability
If the LLC or corporation can't pay their debts, creditors can only go after the company's assets and not the personal assets of the members. That said, the business owner can be responsible for LLC or corporate debts in several situations.
If a business loan is cosigned, the signers are equally responsible as the LLC or corporation when it comes to paying it back. This is the easiest way to make one liable for the company's debts. If an owner personally guarantees some obligation of the LLC or corporation, the creditor can go after their personal assets if the business ends up defaulting on the loan.
If a company is new or doesn't have many assets, the creditor might require them to provide collateral before they approve the loan. If the house or another personal asset is pledged for the business loan, the creditor can later take that property and sell it to meet the company's obligations. A creditor can also go after personal assets by getting rid of the limited liability protection that the LLC provides.
If you need help with determining the liability of your LLC's members, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.