Piercing the Corporate Veil

How Shipwrecks, the Dog Groomer, and Single Member LLCs can Pierce the Corporate Veil

What is the Corporate Veil? And what does that have to do with ships sinking in the Atlantic and paying the dog groomer from your business checking account? Let’s find out.

What is a veil?

I remember hearing ‘corporate veil’ as a kid and thinking it was like a veil like the nuns wore. Or like a bride at a wedding. Turns out, I wasn’t that far off.

A veil is not meant to cover a person completely. Most times, a veil covers the hair or part of the face or is see-through. You still see who it is underneath. It is a little more difficult to see who it is, but it isn’t a mask meant to hide the wearer’s identity. A veil adds a thin, wispy boundary between you and them.

But corporate officers don’t have some secret board room attire where they wear corporate veils at board meetings. They don’t lift the veil and kiss the bride at mergers and acquisitions.

What is the Corporate Veil?

The corporate veil is the protection, the thin, see-through covering, you get from being part of corporation. This extends to LLCs and all the other state-formed entities, including nonprofits, all the way down to the lowly single member LLC.

What does a corporation protect me from? How is my liability limited?

Let’s have a little history lesson:

Back in the 1600s, trade across the Atlantic was all the rage. It was no longer just kings and queens buying and sailing ships, people started to pool their money and sponsor trips to America and back. Sometimes you made a lot of money when the ship came back. On occasion, the ships would sink and everything would be lost. That was the risk you took. However, people back then were no less greedy and legalistic than they are now. When the boat would sink, people would go after one another’s personal property and land to seek repayment for the boat sinking. This didn’t seem fair for a mere investor to lose their whole life and go to debtor’s prison due to a project where they had zero control.

Sinking ships were the birthplace of corporations. People could form a corporation, a legal body, and pool their money for a project. The law protected them to the limit of their investment and no more. If they invested 5000 pounds British Sterling into a ship, and the ship sunk, they only lost their investment, not their home, land, and personal assets. People were more likely to invest since they could only lose their investment, not their whole life. 500 years later, the laws haven’t changed much. If you are an investor (stockholder), you can only lose your investment.

That’s the veil. They can see who you are, but there is a thin, wispy boundary between your personal assets and the money you invested.

How do you pierce it?

Certainly, it is not corporate officers dancing around the board room, pulling out a ceremonial knife, and stabbing someone’s corporate veil.
As an investor in a corporation, your personal assets are protected if you are not directly responsible for the losses. The people that ARE directly responsible for damages are personally liable for their actions, but the investors are not.

In the sad event that you owned Enron stock in the early 2000s, you were not held liable for the bad accounting decisions made by the board and just lost the value of your stock. No one sent you a bill for the massive financial damage done to the employees and vendors.

Let’s scale this down for small business. When it’s just you, you are the stockholders, but you are also the board and also the hired management. So how do you get any protection?

How do you tell the difference between you, you, and you?

This is where recordkeeping is important. Annual meetings, even though they are not required by a single member LLC, show that you hold all three positions and you keep the duties separate.

Clearly signing documents as ‘president’ for corporate decisions, or as ‘manager’ for day-to-day business, draws a clear line. I see so many people sign as ‘owner’. You just signed as the stockholders and lost any protection the veil could offer the stockholders (that would be you).

The most important and easiest way to pierce the veil is in how your spend your money. Technically, it is all your money and you can spend it however you see fit. But to keep the protection of the corporate veil, you need to separate your personal and corporate spending.

The one thing I see people do ALL the time is use their business checking account as a slush fund. They pay for the dog groomer, groceries, kids school activities, cigarettes, drug store, and everything else out of their business account. If you are incorporated, you as the manager are taking company funds and paying your personal expenses. Could you do this at another job? NO. You would be stealing from the company.

Follow the logic here: if it is ok to spend company money for personal expenses and not pay it back, then there is no separation between you and the company. You have pierced the corporate veil. The thin, wispy boundary is gone and you CAN be held liable beyond your investment.

What could you be held liable for?

If you can’t pay your bills, if the company fails, if you can’t finish out your lease, or if there is damage to floor planned inventory, generally, the LLC or corporation would close the business and dissolve in bankruptcy. You would not have to cover the bills personally.

If there was a product liability suit and someone got hurt, or if there was an accident caused by one of your vehicles, or if there was a discrimination or wage dispute, the corporate veil could protect your personal assets.

And don’t forget the biggie: If you are audited by the IRS, and they find this slush fund with no clear plan on keeping the money separate, they could disallow your status and remove any tax benefits of being a separate entity, such as S-corporation status.

I’ve been there. I had an IRS agent look at me and say, “Come on, this is a fake company and you’re just trying to get your client out of paying taxes.” Until I pulled out the corporate record book and five years of meeting minutes.

Who? Me? I’m piercing the corporate veil?

If you are a single member LLC and you have a slush fund for a check book, YOU are piercing the corporate veil every day. When bad things happen, and they always do, you could lose your personal assets (house, car, retirement savings) if you do not keep a clear boundary between you and your business. You took the time and money to set up a separate entity for your business. You need to keep your business dealing separate and you as the manager need to keep the records clear.

Also note: this has no bearing if you file your taxes as an s-corp, a partnership, a corporation, or if you file the business on your personal return on Schedule C. Filing your taxes is subject to a different set of laws than the rules governing your liability. Federal tax law is completely different than liability issues, which are controlled by state laws.

If you have personal spending, move money from the business account to your personal account, then spend it. Have annual meetings. Sign as president when needed (never as ‘owner’). Always keep you and your business separate.
Protect your corporate veil. It looks good on you.