Behaving Like an Entity

may 02, 2019 | operating a business

When business owners form an entity under state law – either a Corporation or a Limited Liability Company – they do so to multiple reasons, the most common of which are:

  1. Need for multiple owners in the business
  2. Limits on personal liability
  3. Tax treatment based on the type of entity selected

Simply forming the entity does not achieve the goal. When the entity is formed, it is an empty legal shell into which assets and activities can be transferred. The owners must take the steps to transfer the business activities into the entity that was formed.

Failure to complete the process, or subsequent failure to behave as an entity can cause the entity to be ignored by a court or by a taxing authority. The legal doctrine of “alter ego” applies when a corporation lacks a separate identity from one of its shareholders, resulting in an injustice to creditors. The conclusion of an alter ego can cause a court to pierce the corporate veil and hold individual shareholders liable for the debts of the corporation. A similar finding by a taxing authority can result in the corporation being ignored for tax purposes.

Stated another way, just because the taxpayer formed a corporation with the intention of starting a business in that corporate shell, it does not necessarily follow that the taxpayer made good on that intention. Matters of taxation must be based on what one does, not what one contemplates.

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