So you set up a corporation or LLC for asset protection. You want to keep your business liability separate from your personal assets. Did you know that if you fail to form the entity correctly or if you fail to perform certain acts each year to maintain your entity, the entity may not actually provide the asset protection you were looking for in the event of a lawsuit?
Before I get into what needs to be done each year to maintain your entity, we should first talk about whether you actually formed the entity in a way that will provide you with some asset protection. Many small businesses form their entity through the Secretary of State’s Office, obtain a taxpayer identification number from the IRS and call it a day. This is not enough. If you are sued, one of the first things that a plaintiff’s attorney is going to do is to request your “corporate records”. If you hand them a copy of your Certificate of Organization (or Articles of Incorporation in the event of a Corporation) and a copy of the letter from the IRS assigning you a taxpayer identification number, that attorney is going to make the argument that you are not observing corporate formalities and that your LLC or corporation should not protect you. This argument is an argument to “pierce the corporate veil”, and it works.
When you form your entity, in addition to filing with the Secretary of State and obtaining a taxpayer identification number from the IRS, you should also (1) order a company book (to keep your company records in), (2) have an Operating Agreement (or Bylaws in the event of a corporation), and (3) have organizational minutes of the members and managers (or shareholders and directors in the event of a corporation). All of this documentation should be filed in your company book.
Once you have correctly formed your entity, you must maintain it annually. Maintaining the entity involves filing an annual report with the Secretary of State each year as well as drafting minutes of the members and managers (or shareholders and directors in the event of a corporation). All of these documents should be placed in your company book each year.
I cannot express how important it is to maintain your LLC or corporation on an annual basis. If you don’t you are taking a big risk. The risk that, in the event of a lawsuit, the entity will not be there to protect your assets.