How Do I Make Sure My Business Entity Protects Me?

Posted on: July 23rd, 2012
Often when someone decides to start their own business one of their most important decisions is whether or not to create a business entity such as a Limited Liability Company (LLC), Corporation, or Limited Partnership (LP). An entity allows the business owner to create a legal entity that is separate and distinct from the owner(s). This means the business can enter into contracts, open accounts, bring and defend lawsuits, and will be liable for its own debts.

     Few people want to go into business and run the risk of being personally liable for business expenses. Most business owners want to keep the business expenses and debts separate from their personal expenses.

     Once the entity is formed and operating it is important to make sure certain principles are followed so the entity keeps is separate legal status.

Keep Your Business Life Separate from Your Personal Life

     It is very important to keep business expenses and liabilities separate from personal expenses and liabilities. So, the business needs to have its own bank account(s) under its own tax ID number. Then, make sure that the business accounts are only used for business income and expenses. So, do not buy personal items such as groceries or gas for your family vehicle out of the business account(s).

     If the business owner starts using the business accounts or money for personal expenses (this is called “commingling”) it is possible a business creditor can have the business entity dissolved. This is called “piercing the corporate veil” and it means that business debts or liabilities may become personal debts and liabilities of the business owner; exactly what you want to avoid.

     For example, if Robert Client uses his business bank account to pay the mortgage payment on his house, it is possible that a business creditor may seek to satisfy a claim that was originally charged to the business against Robert personally.

Follow Corporate Formalities

     There are many things that might fall under this category, but the most common one is to hold regular business meetings and write down what you discuss. This is called keeping the “minutes” of the meeting. In Texas, a corporation is the only entity that is legally required to hold regular meetings, but it is a good business practice for all entities to do so. A business meeting is simply a gathering of the officers (President, Secretary, and Treasurer) where business affairs are discussed and decisions are made.

     If this practice is not followed, then a business creditor may have a stronger argument if they try and have the entity dissolved. Their argument will be that since these meetings were not held the business was really a sham because there was nothing that separated the business from the business owners.

Pay Taxes

     Though this should be obvious, it is very important to pay all business taxes. A business will be subject to a number of federal and state taxes. On the federal level, you will need to file a business income tax return. The type of entity you have will determine what form you need to file. A corporation will file a Form 1120, an S-Corp will file a form 1120-S, and a partnership will file a Form 1065. Also, if your business is paying a salary to anyone then it is also liable for federal unemployment taxes.

     On the state level there are also a number of returns that are due. In Texas there is no state income tax but the business is still liable for unemployment taxes and franchise tax. Information about unemployment taxes can be found here and information on the franchise tax can be found here.

     I found that the number one reason a business entity loses its good standing is for failure to file a franchise tax report. Ordinarily, unless your business makes more than $1 Million in annualized total revenue no tax will be due. Also, if your tax liability is $1,000 or less you will not owe any tax. Here is a tax calculator offered by the Texas State Comptroller. However even if no tax is due the return must still be filed to keep the entity in good standing. If the entity is not in good standing then there is no liability shield to keep the business owner from being personally liable for any business debts or liabilities.

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