- Hi everyone.
I'm attorney Aiden Durham with 180 Law Co in Colorado.
And you're watching All Up in Yo' Business.
(soft guitar music)
On this episode of All Up In Yo' Business.
We're gonna talk about the biggest mistake
that I see single member LLC making
and the things you can do to avoid making
that same mistake in your business.
But before we get into it, don't forget to like subscribe
and share and check the description
for links to additional information and resources.
All right.
So let's cut to the chase.
What is the number one biggest
most common mistake that a single member LLC can make?
In a nutshell,
it's acting like you're not really operating a business.
Thinking that you can just file a form with the state
and start an LLC and boom, you are good to go.
Nope.
Sorry, friends, that's wrong.
So the primary purpose, the main benefit of the LLC is
that it protects you as an individual from the liability
and the debts and the obligations of the LLC.
If the LLC is sued
and it has some damages assessed against it
those are the LLCs liabilities and not yours personally,
at least that's the idea.
And this protection doesn't just come from filing
some form with the state and paying a little bit of money.
You have to actually do things
to keep that LLC protection alive.
I mean, really you think just filing a form, one form
maybe a couple of forms with the secretary of state
is gonna magically automatically give
you personal liability protection?
Not exactly.
And people tend to think
that just because something isn't legally required
meaning there's no actual law or statute saying
that we have to do something means
that we don't have to worry about it.
Most, if not all states,
I don't know all the laws of all the states
but at least most states their statutes will say something
along the lines of an LLC may have an operating agreement,
may have not, shall have, or must have.
So it permits the LLC to have an operating agreement
but it's not required.
And I'm not aware of any statute that says
that an LLC must have its own separate bank account
or it must do this, it must do that.
Most states for the most part are quite permissive
when it comes to how an LLC operates.
But just because something's not statutorily required
doesn't mean that it's not just plain old
a good idea to still do it.
Cause like what's the purpose
of even forming an LLC in the first place
if you're not going to take the steps
to do all the other things that really uphold
and strengthen that limited liability protection.
What's the point in filing a form and paying that money,
if that's all you're gonna do
and you're not gonna take any of those further steps
that may not be legally required
but might still be a really good idea.
LLCs aren't this perfect absolute impenetrable force
that will always protect you.
There's this thing called piercing the corporate veil
which even though it says corporate also applies to LLCs.
A court will disregard the LLC form
and hold the individual member responsible
or liable for the LLCs liabilities.
And this concept doesn't come from statutory law
for as far as I know again,
I don't know all the laws of all the states
but as far as I know there's no statute
that says how and when piercing the corporate veil
might happen in an LLC.
This comes from common law or case law,
instances where a court has decided
to pierce the corporate veil and has given us reasons
for why that's the just an equitable thing to do.
This gives us legal precedent
that we can then kind of rely on and say,
well, in that case, the court said
these factors led to piercing the corporate veil.
So we need to make sure we avoid these factors.
This case law tells us the circumstances
under which piercing the corporate veil might happen.
Piercing the corporate veil is often synonymous
with this alter ego doctrine.
If the LLC is just an alter ego of its members,
then piercing the corporate veil
might be the appropriate thing to do.
Basically if the LLC is just an instrument
for the transactions of the member's own affairs,
then that's often got to kind of fall
under this alter ego idea.
If there's no separateness between the personalities
and the interests of the LLC and its members,
then why would we need to respect the existence of the LLC,
but in many jurisdictions, Colorado included
cause that's where I'm licensed
and that's what I know most about.
In a lot of jurisdictions
it's not just the alter ego that a court will look at.
The court is going to consider
if the LLC is just an alter ego of its members
but they're also going to can take
into consideration if the LLC was used
for some kind of fraud or deceitful wrongdoing
or to really just defeat an otherwise rightful claim.
They'll also consider
if piercing the corporate veil will give
an equitable and just result in the end.
In other words, is this what is going to be fair?
Like if an LLC were sued and the court determined
that the LLC is liable to the plaintiff for whatever,
if that on its own would result in an equitable
and just relief for the plaintiff,
then there's no real need to pierce the corporate veil.
If the LLC is capable and able
of providing whatever kind of relief is ordered
then there's no real need to pierce the corporate veil.
So it's not just about holding members responsible
or liable for the LLCs liabilities.
It's more about making sure the ultimate outcome
is equitable with respect to both parties.
So it's not just if the alter ego thing exists,
there also needs to be some kind of fraud
or deceitfulness and avoiding a legitimate rightful claim.
And we also need to see
if piercing the corporate veil would provide
an equitable result
that we wouldn't otherwise be able to get.
And so this risk of piercing the corporate veil is
a lot higher in a single member LLC
as it is compared to a multiple member LLC.
This is just because the nature and structure
of a single member LLC kind of lends itself
to abuse essentially.
There is no other members, there's nobody else involved
who's keeping an eye on what the single member LLC is doing.
It's a lot easier for a single member LLC
to take advantage of that limited liability protection.
And it's easier for the single member
in the single member LLC
to not really treat the LLC as its own separate entity
and respect that legal distinction between myself
as the member and the LLC as its own business.
And if you're not gonna treat your LLC as a separate
and distinct business, then why would a court do so?
So what can we do to avoid this?
In Colorado there are eight factors that a court will take
into consideration to determine
if the LLC is just an alter ego of its member.
Whether the LLC operates as a distinct business entity.
Whether personal and business funds
and assets are commingled.
Whether adequate corporate records are maintained.
Whether that nature and form of the entities ownership
and control facilitate misuse by the member.
Whether the business is thinly capitalized.
Whether the entity is used as a mere shell.
Whether the member disregarded legal formalities.
And whether business funds
or assets were used for non-business or personal purposes.
Now, even though these are specific just in Colorado
and may not necessarily apply
or apply the same way in other jurisdictions,
they're all generally good ideas, good business practices
to keep in mind and follow,
regardless of where your LLC is formed or located.
And a court is going to look at the specific facts
of each case.
It's not like all eight of these factors need
to exist all the time.
And there's really no one factor
that is especially more important than any of the others.
I mean, for example, let's say the LLC member
has followed all corporate formalities.
They've gotten an operating agreement.
They hold a regular meeting,
they keep meeting minutes or meeting resolutions.
They do all the corporate formality things
we're supposed to do,
but they treat the LLC bank account
as their own bank account
and they dip into it willy nilly
whenever they want or need.
They use business assets for their own purposes.
They treat basically the LLC
as their own personal savings account.
That could be a situation
where piercing the corporate veil might be appropriate.
But on the flip side,
let's say the LLC member didn't
really follow corporate formalities.
Like I said earlier, there aren't many state statutes
that are gonna require an operating agreement
or require the member have meetings
or require that they follow these corporate formalities.
So maybe we didn't do that.
Why should an LLC or an LLC member be penalized
for not doing something that it's not required to do?
If corporate formalities have been disregarded,
but everything else has been operated properly
and rightfully.
And in all other respects the member treats its LLC
as a separate business entity,
meaning there's no mixing or co-mingling a business funds
or assets the LLC has for all intents
and purposes been operated as a distinct business entity.
Then a court may very well determine
that an alter ego doesn't exist
and piercing the corporate veil wouldn't be appropriate.
I think now is a good time to mention
I've got a free downloadable guide
on how to peg yourself in a single member LLC.
You can check that out and find the link in the description.
So the point with all of that is to say,
there are these different factors
that the court's going to look at,
but you don't need to follow
specifically all of them all of the time.
Again, not all of these things are legally required
for an LLC.
And so if everything else is great,
but you just didn't do the things
that you're not legally required to do,
then that may not all the time damage you.
And again, like I mentioned earlier,
it's not just the alter ego thing
that they're gonna be looking at anyway.
Maybe there might be some factors
that kind of look like this is just an alter ego,
but if there was no situation of fraud or deceit
or if the LLC is capable of providing some equitable relief
that is going to be just and fair in the end results,
then piercing the corporate veil
may not really be necessary anyway.
Again, it's not about holding the members responsible.
It's about having an equitable and fair result
in the end with respect to all parties involved.
So there are a few really common questions
that come up when I start talking to people
about single member LLCs and piercing the corporate veil.
Understandably, when I say that the risk
of piercing the corporate veil is higher
in a single member LLC,
the thing that comes up is,
well should I add someone else to my LLC?
Can I add my wife to the LLC?
Should I add my kid to the LLC?
Can I add my brother to the LLC?
What about my neighbor?
Can I add my dog to the LLC?
Should I just add somebody else's name to the LLC,
so I'm not a single member LLC?
No.
Simply adding somebody else's name
for the sole purpose of not being a single member LLC isn't
really going to avoid
that slightly heightened risk of being a single member LLC.
Most of the time at least.
I do have some colleagues in some other states
who have said that in certain situations,
simply having another name,
another member on the LLC can be beneficial.
But again, it's all very circumstantial and situational
and so for the most part
just adding somebody else's name to an LLC,
that by itself isn't going to provide
much benefit or really do any good in most situations.
We need to think about the soul of the alter ego doctrine
and its ultimate purpose and meaning
not just exactly what it's saying.
Let's think about its soul.
It's about this is this, is this business being operated
as a distinct business entity?
Distinct and separate from its individual members.
Is it being respected as an entity
that is legally not the same as its individual owner?
If you're still not respecting the legal distinctiveness
of the LLC and you just throw somebody else in there,
what good is that going to do you?
I'll tell you, not much.
And the second question I get when we talk
about single member LLCs and keeping them separate
and distinct from the individual owner has to do with taxes.
Unless a single member LLC, elects to be taxed
as an S corporation or a C corporation
the LLC is going to be considered a disregarded entity
for federal tax purposes in the eyes of the IRS.
Basically the IRS looks at it
as that the LLC doesn't even exist.
What now, wait a minute.
I'm trying to keep everything separate and distinct
and now you're telling me
that the IRS treats it like the LLC doesn't even exist.
Yeah, that's right.
But that's just the IRS
and we're just talking about taxes.
The LLCs profits and losses are reported
on schedule C to the individual members personal tax return.
And it's basically tax
as if the LLCs income is the member's income.
But just because the IRS is disregarding
the LLC doesn't mean that the LLC is going to be disregarded
in all other respects.
It is possible to have a single member LLC taxed
as a disregarded entity,
but also still treat your LLC
as a separate and distinct business
and not fall into this alter ego situation.
So the moral of the story is this.
You cannot just file a form and pay a couple of fees
and form an LLC and expect that on its own to protect you.
You have to respect the LLC
and honor the fact that it is not you.
It is legally a separate living, breathing being.
The LLC isn't just an instrument for you to do business.
It is a business in and of itself.
And you need to respect that,
'cause if you don't then why should anybody else?
That's all for this episode folks.
Drop a comment below let me know what you think.
And again, don't forget to check the description for links
to additional information and resources including my guide
on how to pay yourself in a single member LLC.
Thank you all so much for watching.
I'm Aiden Durham and I'll see you next time.
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