Can I Be Sued Personally if I Am an S Corporation?

By Roberta Codemo

Can I Be Sued Personally if I Am an S Corporation?

By Roberta Codemo

An S corporation is a regular corporation whose owners, also called shareholders, have elected to apply for S corporation tax status under Subchapter S of the Internal Revenue Service (IRS) tax code. Just like a C corporation, an S corporation is a separate legal entity from its owners. As such, the owners enjoy the limited liability protection of a corporation. Under certain circumstances, however, individual shareholders can be sued personally even if they operate as an S corporation.

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S Corporations and Limited Liability Protection

The owners of an S corporation have limited liability protection. This means that the individual owners are not personally liable for most business debts. If the business is unable to pay its bills, for example, its creditors can only come after the corporate assets, not the individual owners' homes, cars, or bank accounts.

The owners are only fiscally responsible for the amount each has invested in the corporation. For example, if an owner has invested $10,000 in the business, she is only liable for that $10,000. If the corporation has incurred debts of $15,000, the creditors cannot go after that individual's assets to recover the remaining $5,000.

Personal Liability in an S Corporation

There are times when an owner can lose her limited liability protection and be held personally liable for her actions, even while operating as an S corporation. In these situations, creditors can come after the individual's personal assets. Keep in mind this only applies to that individual: the other corporate owners are not affected and retain their limited liability protection status.

Here are some examples of situations where this can occur:

  • Personal guarantee. Sometimes an owner signs an agreement personally guaranteeing to repay a loan. By signing a personal guarantee, that individual—not the corporation—is the party to the contract and, in effect, voluntarily gives up her limited liability protection. If the corporation doesn't make the payments, the owner is legally responsible. The same holds true if an owner signs a business contract in her name. If the corporation fails to comply with the terms of the contract, the owner who signed is personally responsible.
  • Fraud, wrongful, or criminal acts. If an owner willfully commits a fraudulent, wrongful, or criminal act, she can be held personally responsible. For example, if the owner willfully sells a defective product, misrepresents the business when applying for a loan, or assaults someone, the courts strip away the owner's limited liability protection and hold her personally liable. Note that the corporation can also be held liable if the owner was acting on its behalf at the time.
  • Corporate formalities. In some cases, the courts may “pierce the corporate veil," which means they put aside the corporation's limited liability status and hold the shareholders or directors personally responsible for the corporation's debts and actions. For example, if an S corporation fails to follow the formalities and recordkeeping requirements set out in its state's corporate statutes—such as holding annual meetings, keeping accurate minutes, adopting corporate bylaws, or making sure the officers follow the bylaws—the courts may rule that the corporation doesn't exist and the owners aren't entitled to limited liability protection. To avoid such problems, always make sure the corporation is in compliance with state regulations governing the formation and running of an S corporation.
  • Commingling assets. It is important to maintain a distinct separation between business and personal financial accounts and not commingle, or combine, them. Otherwise, creditors can ask the courts to pierce the corporate veil and hold each owner personally responsible for the business's debts. For example, if an owner pays her personal bills out of the corporate account or uses a corporate credit card for personal use, the courts can rule that the corporation is operating as a sham for the owner's personal use and is not entitled to the limited liability protection an S corporation provides. To avoid problems, the owner should never use the corporate account for personal use.

Although incorporating a business generally protects the owners from creditors, this protection is not absolute. To protect your corporate status, make sure to comply with your state's statutes and operate the corporation as a separate business entity.

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.