What Is Piercing The Corporate Veil?

When you incorporate a business, it’s like you have created a person out of thin air. That business is considered a separate legal entity from the shareholders who own the business. In the case of a small business, it’s usually one or two business partners. In the eyes of the government, a business is separated from the owners who run that business. This is different from a sole proprietorship, where you and the business are one and the same. There is no legal separation in a sole proprietorship.

It is not only legally separate, but also taxed separate. At the end of the year, you must also file taxes for personally, but also your business. When you incorporate your business, you’ll get what’s called an Employer Identification Number (EIN) number. This EIN number is similar to your Social Security number. It is what identifies you company with the IRS. So if any customer asks for a 1099 form, you would given them your EIN number, instead of your Social Security.

This separate legal entity is great. If it did not exist, any issues related to your company would be directly the owner’s responsibility. But all is not perfect, since someone uneducated about owning a business might mix their personal, and business transactions. This is a big no no! Intermingling the two can lead to legal, and tax disasters. This is what is known as “piercing the corporate veil”.

PIERCING THE CORPORATE VEIL WITHOUT EVEN KNOWING IT

Many small business owners get tripped up, and pierce the corporate veil without even knowing it. What do I mean by this? If you created a C Corp, S Corp or LLC; it means you should never mix your personal transactions within your business. You should think of your business as if it wasn’t owned by you. When working for someone else, you must get approval of business expenses.

So anything you purchase for the business should be done via corporate credit cards, a company check or at minimum expensed via an expense report. With an expense report, you then cut a check within the company to pay for those expenses. When paying the business partners, it should be a business check that’s paid out to you personally. This is no different when working for someone else. You’ll get a salary just like when working for an employer.

You should not be writing checks from within your company to pay for personal expenses. This means not paying your home mortgage, groceries, or cable bill. Unless of course these are legitimate expenses within your business. When in doubt of what’s considered legal expenses, ask your accountant. If you don’t have an accountant, yet own a business, I suggest that’s the first advisor you get.

Not only can an accountant assist with the complex taxes, but they will help advise you on some of the legal issues. If in doubt pay for any item personally. You can always expense to your business later.

When owning a business you don’t have to become an expert in accounting and tax law, but you should at least understand the basics.

If you keep your personal and business expenses separated, it will protect you from legal trouble. If you pierce the corporate veil too much, a judge may determine you personally liable for business transactions. This is not to say you should purposely fraud partners, vendors or customers. This can also pierce the veil and there are many other examples in which this could happen.

Bottom line: If you have a business generating any significant income, and serious about growing the business you should incorporate. While the initial costs, reoccurring costs and overhead is not minor it will save you many legal hassles in the future, with also tax advantages to boot!

This has been a guest post by Investor Junkie. 

FURTHER THOUGHTS AND QUESTIONS FOR ALL OF YOU

I asked Investor Junkie to share his thoughts on this subject because he’s an entrepreneur and I’ve seen so many companies get in trouble with using a company’s funds for their own personal use.  There are also many of us online entrepreneurs who might be tempted to use company funds to buy a car they don’t need, go on a vacation that’s irrelevant to the business and so forth.  There’s such a gray area and I can see the temptation!

For example, I’m going on a European cruise this fall.  Since I will be meeting up with a couple potential clients for the Yakezie Network, is my round-trip plane ticket fully expensable?  What about at least one hotel night stay a the 4 Seasons in Barcelona?  And how about my entire cruise itself if I so happen to meet more customers on the ship?

One online friend earns probably north of $30,000 a month from his site, but takes only a $5,000 a month income so he doesn’t have to pay payroll taxes of 12.4% on the remaining $25,000 a month.  That’s $37,200 in payroll taxes saved on $300,000 a year in annual income that flows to retained earnings on the corporate balance sheet.  The problem is, with only a $60,000 a year income, it’s going to be difficult getting more than a $200,000 a mortgage, which doesn’t buy very much house where he lives.  Does he buy a house using his company’s funds and pierce the corporate veil?  After all, it is his company.

Can one load up their company with loss making assets such as an income property to offset profits?  Since a corporation is a separate entity, is it considered piercing the corporate veil if a relative or parent is hired to pay for services rendered?

Let’s get this discussion going entrepreneurs and business folk alike!

Thanks, Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Darwin's Money says

    For one, I’d avoid form my own LLC rather than paying a company. The one your link directs to pulled some shady nonsense where each year after I formed my LLC through them, they attempted to extract hundreds of dollars from me for being a “registered agent”. All that means is if someone wants to serve you papers, there has to be a physical mailing address to serve you. So, instead of a PO box or whatever, you have to list your home address as the LLC address. I had mentioned to my accountant this recurring fee and he said that’s stupid to just update myself as the registered agent.

    So, I did and guess what? Even after numerous phone calls, and I mean numerous, they continued to harass me for money and kept claiming I was still in their system. I was already registered by the state and told them repeatedly to cancel all affiliations with my account. Eventually I started getting collections letters and they were going to have agencies start calling me. It was absurd. No matter how many people I talked to, managers, customer service reps, etc., they kept saying I was removed from their system and then I’d get another threatening letter. This was all while I was looking to buy a new home and didn’t want a black mark on my credit rating.

    So, they pissed me off immensely, and after threats from my end and over 1 year of harassment, they finally got their act together and removed me from their system.

    Bottom line? File an LLC yourself (just google your state department’s entity formation site) and list your home address as the LLC address. If someone wants to serve you with papers (which is about 1 in a million as a blogger), they will find you. You don’t need to pay some d-bag company hundreds of dollars per year to act as an address.

  2. JT says

    What Darwin said is pretty important. A registered agent is no big deal, and important only if you want to file an LLC in another state where you don’t have an office/don’t want to deal with the mail/potential legal challenges. Otherwise, you might as well be the RA.

    Anyway, I’ve found filing for an LLC to be a piece of cake, but I’m sure that varies by state. It took me all of 10 minutes online, a few minutes to get an EIN, then bank account, then on down the line. I’m sure in states like CA and NY it’s a PITA.

    As for Sam’s questions, real estate is tricky. I assume that the loss generation from a real estate transaction would be due to depreciation, which if I understand correctly, isn’t exactly the same for a passive investment through a corporate entity than if placed on corporate balance sheets. The rules for depreciation with passive income have changed so much that I don’t even want to steer someone the wrong way, though.

    • Financial Samurai says

      I’m really inquiring about ANY loss making business to inject in another business to use those losses to counteract the profits to pay less taxes. OK by the government? I seem to see public companies time after time do this for tax reasons.

      Thx

  3. Untemplater says

    Having clean books is key if you have your own corporation. Staying on top of payroll and the accounting isn’t that hard once you get the hang of it and there are plenty of people and companies you can outsource those tasks to as well.

    I can see how it’s tempting to dip into the company funds if you are running things yourself but any good accountant will warn you not to do that and will likely drop you as a client if they find suspiscious activity like that. Afterall their license is on the line.

    For travel expenses you have to be careful only to claim the percentage of costs associated with real business and there are all kinds of rules on what and how much.

  4. krantcents says

    The real benefit of owning income property is beneficial to individuals. The exception is commercial property such as the building your office is located. The benefit is instead of you paying rent, you are paying down a mortgage and the tenants are helping you. The depreciation will shelter some of you income. Eventually, it will generate significant income. A lot of doctors do this with medical buildings. I worked for a company years ago who was a partnership and owned their industrial buildings in separate partnerships. They wanted the benefits to flow to the individuals in the partnerships.
    When I owned income property and businesses, it was important to have good resources to use such as a CPA, Attorney, banker and real estate professionals. I like having smart and dependable people around me that I can use at anytime.

      • Eric J. Nisall says

        The superman(woman) complex is all too common, and it’s not only that but they try to save on the expenses, when it may end up costing more in the long run, especially if they screw something up trying to do it themselves. Things like accounting and law are two areas where the expenses are more than justified and ones that I would encourage.

  5. Sunil from The Extra Money Blog says

    this is great stuff and boils down to keeping each business and its transactions separate. as far as pumping in loss leaders, i am pretty sure this is not ok w/o adequate business reason. few years ago companies like MSFT were buying companies with huge NOLs to take advantage of them . . i am pretty sure this practice was disallowed at some point. i am sure some can justify strategic transactions/moves that aim to achieve the same

    • Financial Samurai says

      Guess I’ll just have to talk to an accountant. If there are business synergies and legal, then why not? With a small business, it’s about maximizing lifestyle and minimizing profits bc they’ve all been spent!

  6. Eric J. Nisall says

    Keeping personal and business transactions segregated is of the utmost importance. I’m working on a post now about this, but I’ll say it here too: your “business” can be terminated and all of the deductions charged to you as personal income if the IRS deems it to be a hobby or worse, a way to write off everyday expenses. That is why separation is so important. IF you need to get some money for personal reasons, there should be a check written to you and the memo should be “shareholder loan” or something of that nature in order to have a paper trail and keep everything above board, or better yet issue yourself a bonus to keep it even more proper.

    Sam, for your trip, that all depends on the person doing the books and the tax return. You can definitely take the expenses for any business-related meetings, meals, entertainment, and lodging while in Europe. What it comes down to is how far you want to push the envelope: some people will deduct a portion of the airline fees, even though the trip may be predominantly for pleasure, especially if the business portion didn’t require the travel oversees.

    Your friend should never use company funds in that manner. What he can do is give himself a bonus at the end of the year which is totally acceptable. This way, he will have reported the income, paid the proper taxes, and the source won’t be questioned. But to be honest, if it is an S-Corp, the net profit is meant to be distributed at the end of each year. Also, there needs to be a reasonable amount of salary to the shareholder which generally is determined by the type of business. If they try to take out money in the form of distributions (which are non-taxed generally) that significantly exceed salary, then they could be in trouble for attempting to circumvent the payroll taxes which is a bad thing

    • Financial Samurai says

      Eric, thank you for your wisdom and insight! I’m looking forward to reading your follow up post on the subject.

      Say I pay myself $50,000 a year as an S Corp, and corporate income is $200,000 so that $150,000 is left over. How much in distribution income can I distribute to myself out ofthe remaining $150,000 so as to be deemed kosher in your opinion?

      Deducting a percentGe of the Euro trip sounds like a good idea. Let’s say I bring in a $25,000 revenue opportunity, a $10,000 deduction sure seems legit no?

      Sam

      • Eric J. Nisall says

        With the example you gave Sam, all of the $150,000 can be distributed to you without tax consequence. You need to realize that when you get a K-1 from an S-Corp, the net tax income is reported to all of the shareholders, and they are reporting that on their 1040 as earned income, and paying tax on it. If you are the only shareholder, and the net tax income on the 1120-S is $150,000 that amount is being reported on your 1040 Schedule E, and you are paying tax on it, so when it gets distributed to you the tax is already covered. Now, you will do very well the next year to reassess your situation and take a larger amount of salary so that you have more federal withholding paid in.

        As far as the Europe trip, I meant you can deduct the expense for business purposes as a percentage of the entire trip, not as a percentage of the potential income, since you can’t substantiate the $10,000 you mentioned. For example, if you spent 90% of the trip on business matters with potential clients, and the other 90% was pleasure, then you could expense 10% of the travel costs (flight, hotel, car rental) and 100% of the expenses discussing business (meals). Hope that clears things up a bit.

        I think the post will go up later next week. I have that one and the Yakezie blog swap post to work on over the next few days.

        • Financial Samurai says

          To Clarify further on the $150k, bottom line, as the sole shareholder who gets that distribution, you are paying tax on it no matter what. But what you don’t do is pay the extra 12.4% payroll tax on the 150k in an S corp right? The net after tax of 150k should stay on the corporate balance sheet and not be used by me to go party it up in Vegas yeah?

          I hear you on the Euro trip expense. I’m just saying that after the fact ie one month after I come back, and gain $24,000 in revenue from a relationship I met there, deducting the entire $10,000 trip sounds justifiable to me. Does it not to you?

        • Eric J. Nisall says

          Correct. There are no further taxes on that bottom line amount. What is supposed to happen, is that after the return is completed, there should be a check cut for that money that went into retained earnings. Or, you can put it into the company as a loan, or a combination of both. You could go to Vegas with that money, if there is a blogger conference or something that you can expense as business, there’s nothing wrong with that.

          But, you can never deduct any part of personal expenses against the business, regardless of how much income was produced by the trip, if any. The only expenses you can deduct are those that are directly business-related, and quantifiable. And that is the case even if the people you meet with blow you off. What you spend on the vacation portion is a lost cause.

  7. Marie at FamilyMoneyValues says

    I would have to refer all of Sam’s questions to my lawyer/accountant. However I would like to add that in order to keep your veil up, you also need to file any paperwork required by your area government. In my state, we just have to hold an annual meeting with the llc members and keep written notes of that meeting on file in the business. In other areas, however, there are requirements to file certain information with government offices and have it publicly recorderd.

  8. youngandthrifty says

    Those are great questions! I think your european cruise should be deductible (the portion you use for your business) because you are there on business. The CRA (Canada Revenue Agency) allows for deductions on expenses incurred to earn income.

    I think people expense things like bloggers conventions and flights there (FNCON’11?? hehe) all the time.

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