The Importance of Following Formalities in Creating and Operating Your Business
By Steve and Kiley Stuchlik, Attorneys at law
Many people have been able to successfully create an entity for their business through the respective state processes available online. In Idaho, for example, it is relatively simple to create an Idaho LLC using the online portal at the Idaho Secretary of State’s website.
Creating an entity for your business is a good idea. Creating a limited liability entity can shield your personal assets from attachment by business creditors, potentially save you some money come tax time (you should speak with your CPA or other qualified tax advisor about these potential benefits), and can provide a streamlined mechanism to transfer the business from one generation to the next.
When it comes to achieving the “limited liability” aspect of an entity, though, individuals must be aware that there is more to setting up a business entity than just filing the initial paperwork with your state’s Secretary of State. You must formalize the arrangement with the adoption of entity creation documents, such as bylaws and articles of incorporation for a corporation and an operating agreement for an LLC. Even if you are a single-member LLC, you should sign an operating agreement—it will be an agreement between yourself as the sole member of your LLC and the LLC. Executing the operating agreement may feel awkward, as will following other business formalities such as holding an annual meeting for your business (and being the only attendee in the case of a single-member LLC), leasing property or equipment to your business, and formalizing loans to your business by executing a promissory note. Such formalities, however, must be followed in order to erect a barrier between you and your business so that you are not regarded as an “alter ego” of your business and can therefore, enjoy limited liability when it comes to your personal assets. The following case from Texas serves as a recent example of this point:
United States v. Lothringer, No. 20-50823, 2021 WL 4714609 (5th Cir. Oct. 8, 2021)
Arthur Lothringer formed a corporation, Pick-Ups, Inc., and was its sole director, officer, and shareholder. The United States sued Lothringer, his wife Janet, and Pick-Ups to collect federal taxes. The district court found that Pick-Ups was Lothringer’s alter ego under Texas law because “there is such unity between corporation and individual that the separateness of the corporation has ceased and holding only the corporation liable would result in injustice.” The court relied on undisputed facts showing that Lothringer exercised complete dominion and control over Pick-Ups, failed to observe corporate formalities, loaned substantial money to Pick-Ups, and made personal loan payments from the corporate bank account. As a result, Lothringer was personally liable for $1,777,047 in federal taxes owed by Pick-Ups.
Takeaways: The $1.7 million judgment against Lothringer is a good reminder that business owners, especially sole shareholders or sole members of single-member limited liability companies, should erect strict barriers between their personal and business affairs and transactions and comply with all corporate formalities to avoid personal liability for business debts and obligations. *
Creating an entity for your business is a worthwhile endeavor whether your goal is to limit liability, save money, or as part of your estate planning. But if achieving limited liability is your goal, the barriers between personal and business matters must be erected and maintained. If you want to create a business entity correctly with all formal arrangements or need assistance in formalizing a business entity that you have already created, we can help.
*Source: WealthCounsel Newsletter, November 2021. http://info.wealthcounsel.com/blog/current-developments-in-estate-planning-and-business-law
Steve Stuchlik - Attorneys at Stuchlik Law PLLC practicing estate planning, probate, real property, and local government law.