LLC Legal Protection: Everything You Need to Know
LLC legal protection includes the personal liability protection offered by a limited liability company, a type of business entity that is legally separate from its owner or owners. 3 min read
LLC legal protection includes the personal liability protection offered by a limited liability company, a type of business entity that is legally separate from its owner or owners (known as members). Limited liability protection means that your personal assets cannot be seized to pay for debts and financial obligations of the LLC. An LLC operates as a pass-through tax entity, which means the members report profits and losses on their individual tax returns as they would for a partnership or sole proprietorship.
LLC Liability Protection
When creating a new business, it's important to consider the liability risk you take on and avoid as an LLC owner. While all LLCs offer their owners limited liability, the extent of this protection varies by state. In general, though, LLC legal protection covers:
- Personal liability for the debts of the business
- Personal liability for the actions of other LLC members or employees
- Personal liability for your own actions associated with the LLC
- LLC liability for members' debts and financial obligations
Personal Liability for LLC Debts
In most states, members are not responsible for the debts of an LLC unless they provide a personal guarantee for these debts. That means business creditors can go after the accounts and property of the business to pay these debts, but the members' individual assets are protected. Some creditors may ask for a personal loan guarantee, which means that you will be personally responsible for covering any debts left unpaid by the business.
Personal Liability for Members' Actions and Debts
The protection afforded by your LLC extends to wrongdoings and unpaid debts of other members and employees. If the business is found responsible for these actions, the LLC accounts and assets can be seized, but your personal assets are safe. The member who is involved in the illegal or negligent actions may be held personally responsible, however. For example, if an employee kills a pedestrian while making a delivery for the LLC and is found to be negligent in that accident, the LLC's assets and those of the employee in question can be seized to pay the legal judgment. Your personal assets cannot be touched.
Liability for Your Personal Actions
If you commit wrongdoing in the course of operating your LLC, you will be personally responsible for these actions. This may include instances in which:
- You personally injure someone due to negligence.
- You do not deposit taxes taken out of employee wages.
- You intentionally commit fraud or another legal or reckless action that harms the LLC or another person or entity.
- You mix your personal affairs and accounts with those of the LLC.
The last item above is the most important. If personal and business funds are mixed, the court might decide that the LLC does not exist and therefore, that all members are personally liable for its debts and obligations. Prevent this occurrence by:
- Truthfully and fairly representing finances and material facts to customers, creditors, and vendors
- Investing enough money in the business so it can cover debts and obligations
- Registering for an employer ID number (EIN) with the IRS and establishing a business checking account for the LLC
- Creating a formal operating agreement, which details the administration and operation of the LLC
Consider the example above. If you knew your employee was driving drunk when he killed the pedestrian but allowed him to operate a business vehicle, you could be considered personally liable and your assets can be seized to pay damages.
LLC Liability for Member Debts
Although the LLC's assets cannot be seized to cover the personal debts of members, creditors can take legal steps to satisfy these debts depending on the state. These may include:
- Getting a charging order from the court demanding that the LLC pay the outstanding debts
- Foreclosing on the LLC ownership interest of the member in question
- Getting a court order for dissolution of the business
If the ownership interest is foreclosed on, the creditor becomes the owner of that member's financial rights. If the LLC is dissolved, it will have to sell its assets and cease business operations. Most states require the creditor to start by obtaining a charging order.
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