Who Is Responsible for the Liabilities of a Corporation?

Key Takeaways

• Sole proprietors and partnerships are personally responsible for business liabilities and taxes, as the business and owners are not legally distinct.
• LLCs offer liability protection but may be taxed like sole proprietorships or partnerships unless they elect corporate taxation.
• Corporations are separate legal entities, meaning owners are generally shielded from liability unless specific exceptions apply.
• Corporate officers, directors, and shareholders can be held personally liable in cases of fraud, co-mingling of assets, inadequate capitalization, or failure to follow corporate formalities.
• “Piercing the corporate veil” is the legal doctrine that allows courts to hold individuals liable for corporate debts under certain circumstances.

Knowing who is liable for corporation tax can be an ongoing issue for various businesses, as sole proprietorships, limited liability corporations, and corporations are all taxed differently. If you are a business owner, understanding the structure of how your company was established will help you in understanding how to correctly pay your business tax. After all, you certainly do not want to be one of the businesses who is contributing the over $100 billion that is owed in taxes, according to the Internal Revenue Service.

How Is a Sole Proprietorship Taxed?

If you are a business owner who operates a sole proprietorship, the government is going to view you (as the business owner) and the company as essentially being one in the same. So, what does this mean for you insofar as your business taxes are concerned? Basically, it means that the IRS does not tax the business, but rather it taxes the income of the business owner, as the owner of a sole proprietorship owns all the assets and liabilities of the business.

How Is a Partnership Taxed?

Partnerships are not taxed all that differently from a sole proprietorship. However, rather than just one person being responsible for the assets and liabilities of the business, the various partners are responsible for paying the taxes as part of their respective personal income tax.

How Is a Limited Liability Corporation Taxed?

A limited liability corporation, also known as an LLC, can be taxed a bit differently depending upon the number of people involved. For example:

• If registered as an LLC, but having only one member, it is going to be treated as a sole proprietorship
• If an LLC has co-owners, then it will be taxed the same way as a partnership
• Liability for unpaid taxes are treated the same way in an LLC as they would be for either a sole proprietorship or partnership, depending upon the number of members

With that said, an LLC can choose to be treated as a corporation for tax purposes.

In the case of corporations, they are viewed as separate entities from the owners, therefore the owners do not include the taxes for the business in with their personal income taxes. Even though the company’s owners may not personally be on the hook for having to pay corporate taxes, if they are employed by the company, then they will have to pay personal taxes on that income. Additionally, if the corporation pays dividends to it’s shareholders, then they are personally responsible for reporting that on their personal taxes and paying, accordingly.

Only the taxable profits earned by the company will be subjected to taxation, as there are some expenses that are tax-deductible. Some tax deductible expenses include:

• Salaries and bonuses paid to employees
• Costs that are associated with the medical and retirement benefits of employees
• Company start-up costs
• General operating expenses

Many companies will keep a very close eye on these various expenses as a means of reducing the amount of money on which they will have to pay taxes.

While salaries and bonuses are tax deductible, dividends are not. As such, just as the shareholder must report any dividends received on their personal taxes, the corporation must report it as well. This means that dividends that are paid out, are basically taxed, twice.

Generally speaking, this is only an issue for larger companies whose shareholders are not necessarily employees; in the case of smaller companies, the shareholders frequently are employed by the company, and therefore are only paid a salary, which is tax deductible for the corporation.

While sole proprietorships and partnerships are generally only paying taxes at the end of the calendar year, as it is the owner (or, owners) who are paying the taxes, personally, a corporation has a different pay schedule. Corporations are required to file an IRS Form 1120 and estimate the amount of taxes owed (based on income, deductions and the corporate income tax rate) on a quarterly basis, on the 15th of the appropriate months. This means that on the 15th of every April, June, September, and December, the IRS is going be expecting the quarterly tax payment from a corporation.

When Owners Can Be Personally Liable in a Corporation

While corporations generally shield their shareholders, directors, and officers from personal liability for business debts, there are key situations where that protection can be lost:

1. Piercing the Corporate Veil
   Courts may “pierce the corporate veil” and hold individuals personally liable if:
   • The corporation was undercapitalized from the start.
   • Personal and business finances were co-mingled.
   • Corporate formalities (like maintaining meeting minutes or separate bank accounts) were not observed.
   • The corporation was used to commit fraud or illegal acts.
2. Personal Guarantees
   A corporate officer or shareholder may voluntarily sign a personal guarantee when securing business credit or financing. In this case, they are contractually obligated to repay the debt if the corporation defaults.
3. Unpaid Payroll Taxes
   Officers or those with financial authority can be held personally responsible for unpaid employment taxes under the IRS Trust Fund Recovery Penalty (TFRP).
4. Tortious Acts
   Individuals may be held liable for their own negligent or wrongful actions, even when acting on behalf of the corporation. This includes cases of fraud, harassment, or violations of labor laws.
5. Statutory Liabilities
   Some federal or state laws impose specific liabilities on individuals, such as environmental violations or certain regulatory fines.

Understanding these exceptions is critical for anyone managing or investing in a corporation. Properly maintaining corporate formalities and avoiding financial co-mingling can help preserve limited liability protections.

Who Pays Corporate Tax and When?

Corporations are responsible for filing Form 1120 and paying taxes on profits at the corporate level. This tax is separate from personal taxes paid by shareholders or officers. Corporations must also:

• File and pay quarterly estimated taxes: If the business expects to owe $500 or more in corporate income tax, estimated payments must be made in April, June, September, and December.
• Report dividends paid to shareholders: These dividends are not tax-deductible for the corporation and are taxed again at the individual shareholder level—resulting in “double taxation.”
• Track deductible expenses: Corporations can reduce their taxable income by deducting salaries, employee benefits, startup costs, and other business-related expenses.

Frequently Asked Questions

• Who is responsible for the liabilities of a corporation?
  Generally, the corporation itself is liable for its debts. However, shareholders or officers may be personally liable if they engage in fraud, fail to follow corporate formalities, or personally guarantee corporate debts.
• Can an LLC be held liable like a corporation?
  Yes, but it depends on how the LLC is taxed and structured. Single-member LLCs are taxed like sole proprietorships, while multi-member LLCs resemble partnerships. LLC members usually have limited liability unless exceptions apply.
• What does it mean to “pierce the corporate veil”?
  This legal concept allows courts to hold corporate owners personally responsible when they misuse the corporation—such as by mixing personal and business funds or engaging in fraud.
• Are business owners ever responsible for unpaid taxes?
  Yes. Business owners or officers can be held personally liable for unpaid payroll taxes and other trust fund taxes under federal law.
• What happens if corporate formalities are not followed?
  Failure to maintain separate financial records, hold annual meetings, or issue stock properly can result in loss of liability protection, exposing owners to personal financial risk.

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