Piercing The Veil of Single Member LLCs
The limited liability company has become a monstrously popular business entity for small businesses. As with most of its ilk, the entity has positives and negatives. This is particularly true when it comes to the issue of piercing the veil of single member LLCs.
States each have their own laws governing if and how LLCs can be formed in their state. Many allow for a form of the entity where there can be one owner. Most people now realize this can cause a problem with taxes because the IRS does not recognize these entities when they choose to be taxed as a partnership. While the disregarded entity ruling by the IRS is problematic, there is a second problem with single member LLCs that are even more lethal.
Why do you form an LLC or corp? To gain protection from the debts and liabilities of the business. This protection is created by the corporate shield. Suing parties, known as Plaintiffs, will often try to get around this shield. This is known as piercing the veil and it can be a real problem with single member LLCs.
So, what is the problem? Well, most single member LLCs are formed through cheap online services. The member receives the LLC and then assumes the business is ready to go. It is not. The entity is valid for legal purposes when initial documentation like operating agreements, issuance of interest, security filings [when necessary] and capitalization occur. The vast majority of these new LLCs never have any or all of this done. This opens them up to claims of piercing the corporate veil, a claim that is successful over 40 percent of the time in California, for instance.
There is nothing inherently wrong with single member LLCs so long as they are set up and maintained correctly. Unfortunately, most are not. This creates a false sense of security for their owners, one that is a time bomb just waiting to explode. To avoid such problem, you should get an attorney to look into and fix the errors.
Richard A. Chapo writes about the single member LLC time bomb for his site at SanDiegoBusinessLawFirm.com.
