Can Forming an LLC Protect Your Personal Property?

By Roberta Codemo

Can Forming an LLC Protect Your Personal Property?

By Roberta Codemo

Forming a limited liability company (LLC) can protect your personal property from business creditors, but this protection is not absolute. This type of business structure operates as a separate and distinct entity from its owners (referred to as members). However, states vary in their rules and regulations for LLC formation. It's best to check with your state's filing office—usually the Secretary of State.

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Limited Liability Protection

Owners have limited liability protection, which means they are not personally liable for the business's debts or obligations. If the company cannot pay its bills or satisfy a judgment against it, any business creditors can come after business assets only.

The owners' personal assets—homes, cars, or bank accounts, for example—are out of the reach of creditors. But any capital contribution that the owners made (e.g. cash, personal property, or intellectual property) could be at risk. This limited liability protection is one of the primary reasons that a business forms as an LLC.

Personal Liability

Under certain circumstances, however, an owner can lose their limited liability protection and be held personally liable for their actions when acting on behalf of the business. Such circumstances include when an owner:

  • Personally guarantees a loan, takes out a contract in their name, or uses a business credit card for personal use
  • Fails to deposit payroll taxes
  • Commits a crime or knowingly commits a fraudulent, illegal, or reckless act
  • Injures someone due to negligence

Under these circumstances, creditors can seize not only the owner's personal assets but the business's assets as well. The co-owners, meanwhile, retain their limited liability protection. Likewise, a creditor cannot touch the business assets to satisfy a personal debt against an owner, even if the business asset belongs to the owner, such as the owner's capital contribution. However, in certain circumstances, a creditor may:

  • Get a court order, also called a charging order, dictating that the business must pay the creditor
  • Foreclose on the owner's ownership interest
  • Have the company dissolved

The actions that a creditor can take varies by state. While all states allow creditors to obtain a charging order, other states also allow a creditor to foreclose on the owner's ownership interest or have the company dissolved.

Alter Ego

Creditors may also claim that the company is a sham and that the owners are operating the business as an extension of the owner's “alter ego"—meaning it is merely a legal shield for the owners' personal affairs and not a legitimate separate business. In these circumstances, the courts often rule that an LLC isn't entitled to limited liability protection and hold it and the owners personally liable for the business's debts and obligations. This action is called “piercing the corporate veil." However, the courts only impose personal liability on the owners responsible for the business's wrongful or fraudulent actions.

Courts pierce the corporate veil when business owners:

  • Commingle personal and business funds. Examples of this are when an owner deposits business funds into his personal account or pays personal bills with a company credit card.
  • Fail to follow business formalities. Companies must maintain accurate records and follow the rules set out in its state's statutes regarding business operations.
  • Treat the business as their alter ego. In this case, the business is a cover that the owners have set up merely to protect their personal assets.
  • Undercapitalize the business. Owners need to make sure there is enough money to cover business expenses and liabilities.

Forming an LLC separates your personal assets from your business assets, but it doesn't give you total protection. There are circumstances where you could be held personally liable for your actions. Understanding these circumstances can help protect your personal property in the long-term.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.