Why would someone start, own, or run an unlimited liability company nowadays?

Factual Questions
1

When I was young, I was taught about the basic forms of for-profit companies that exist in the US, namely sole proprietorships, partnerships, and corporations. A major difference was that the corporation had what was called limited liability - if the company did badly, the owners stood to lose only their investment. On the other hand, if you invested in a partnership and the company hit rough times due to another partner’s mismanagement, the partnership’s creditors could come to your house and tow away your car and garnish your bank account to pay the company’s debt. A big idea was that having limited liability corporations made it easier to raise a little bit of capital from a lot of people. Perhaps many people would be interested in investing $5000 toward owning a thousandth of your company knowing that they might lose it all if the company did really badly, but few, if any, would be willing to do it knowing that not only could they lose their $5000, but they could lose their home and end up on the streets. There was also this newfangled thing called the LLC that was sort of like a partnership but provided limited liability like a corporation.

Are there any advantages to owning an unlimited liability company nowadays over a limited liability one? For example, if Joe the Entrepreneur wants to start a company, he can choose to make it a limited liability company and protect a big chunk of his assets. If there were no downsides to this, it would seem like a no-brainer - why risk your home when you don’t have to? Do unlimited liability companies have an easier time getting credit because banks know that when times get rough, the bank can start towing BMW’s?

2

If Joe the Entrepreneur signs a loan contract with a bank for financing his new corporation he very likely will get better terms on the loan than would Joe, Inc. exactly because his own personal assets will help back the loan while with a limited liability corporation only the corporate assets would back the loan. That is since limited liability protects Joe, it hurts his creditors and he might not be able to go into business at all that way.

3

I would think unsecured loans would be all but impossible for LLCs. People could set up a LLC for a pittance, get a sizeable loan, then simply walk away whistling and dirt-free.

I very well could be wrong in this assumption, but it’s the idea I’ve always come away with.

4

It would seem like a cheap way to protect assets. Oops, can’t pay my credit card bill, guess you guys can’t do anything because the accountholder was robert_columbia Credit Consumer, Inc., a Delaware Corporation. The only assets the company has are whatever I give it to pay “my” bill. If you sue, I’ll have it file bankruptcy and then start up a Cayman Islands Holding Corporation to own the new Texas LLC I’m setting up to own my new robert_columbia Personal Credit Card Usage and Payment Services corp that’s being registered in the Bahamas through a wholly-owned Peruvian mutual fund my broker is setting up. If I hit someone with my car, it turns out that my car is actually owned by robert_columbia Transportation Services, LLC and I was an employee on a business trip, yeah. Where was I going on business? Well, even though I own the company I was driving in the role of employee, and I was told as a matter of company business to go to the bar on Saturday night in case a big business opportunity came up there. Don’t ask me what management’s got in their big heads nowadays.

5

That’s assuming that the credit card company would grant a credit card to robert_columbia Credit Consumer, Inc. in the first place.

If you have a shell corporation that has no business and no assets, why would a credit card company issue it any credit?

6

That’s my understanding. When a fresh young entrepreneur starts a business and goes to the bank for financing, the bank would need security for the financing. If the LLC has literally no assets, then the bank would turn down the application, unless the fresh young entrepreneur is willing to pledge his/her own personal assets as back-up security.

Then, if the LLC goes under and the bank doesn’t recover in full, it would have the option of going after the fresh young entrepreneur’s assets, under the personal security guarantees the entrepreneur gave to induce the bank to issue credit to the LLC.

7

My wife ran a sole proprietor business for a number of years. She had no debts although I suppose there was a tiny possibility that a disgruntled customer might sue and win more than the insurance her professional society (of translators) provided. On the other hand, think of all the business fees and business licences she avoided. And a business operated from home violates local ordinances anyway. I think the local ordinances were to prevent traffic, but the only traffic she generated were a visit once or twice a week from a courier service. Eventually, the only traffic was over telephone and then cable lines. In any case, I think there was only one occasion that a client even complained.

8

We have a similar set up in the UK. HMRC has recently clamped down on self employed ‘sole traders’ who only have a single customer. This was to prevent us from using it as a way of paying less tax when we are really an employee in all but name.

The alternative is to become an LC, but the advantages for a sole trader, even one with only one customer, will often outweigh the disadvantages.

9

Even real companies with substantial sales and assets generally can’t get loans or credit card accounts without unconditional personal guarantees. Lenders aren’t stupid and there’s little incentive to not require. Its boilerplate and they all require it.

10

If you managed to do this the bank will assume you did this purely to get the cash for yourself and calls police to press charges for fraud…you go to jail.

As a CEO you can be held personally accountable for gross fiscal abuses.

11

Yes, IIRC the deliberate actions of an officer of the corporation can make them personally liable - if it looks like you planned to rip off the bank, for example; to borrow with no plan to pay back.

12

Banks, credit cards, landlords, etc. all require personal guarantees on small companies. You won’t have any limitation of liability until your company is valued in the millions… and maybe not even then.

So there’s your primary misconception. 99% of LLCs owners have no change in their liability because of the LLC.

This is even true in many areas of tax. The IRS holds the owner of a single-member LLC personally liable for payroll taxes, and may also find other “responsible parties” liable in other companies. (Responsible parties are those who could and should have been making the payments, basically.) Washington state holds the responsible party of any kind of company personally liable for unpaid sales tax and payroll tax. So the CEO of a corporation may find himself personally liable for failure to pay taxes.

But surely there’s protection from law suits and other legal obligations? Maybe… but maybe not. Check your state laws and talk to your lawyer, but most professional types of liability (malpractice, error & ommissions for example) can hold the individual responsible even in an LLC. (In WA, it’s not even legal for a doctor to work in an ordinary LLC. You’d have to go with PLLC, which have slightly different rules).

As for why you’d start a sole proprietor or partnership… in part, because it’s the default. If you and I shake hands and say “Let’s do business together” we’ve formed a partnership. We may not have registered it yet, but you don’t have to register a partnership to create it - you just have to shake hands. (I’m using shake hands in a figurative sense for actions that show an intend to form a partnership.) So, unsophisticated business people often form unlimited liability companies simply because they don’t really understand the options.

Even then, I’ve already pointed out that limited liability is a mirage for most owners in most situations. Why have the added cost and administrative overhead when it provides no actual benefit? So, even sophisticated business people may prefer the simplicity.

If you ask me, the best reason to form an LLC is so that you can change your method of taxation with the IRS without needing to open new bank accounts every time. Most other benefits are more hype than reality.

(But consult with your attorney, tax professional, etc. before making a decision. Each individual situation is different.)

13

AFAIK, if I open up a barbershop as a sole proprietor, income will be reported directly on my 1040. If I formed Barber Inc., resulting profits would be taxed twice: the corporation would pay a tax and then I would pay a tax on the dividends.

14

Underwriters at Lloyd’s of London have unlimited liability, as some rich “names” learned to their dismay. The liability can be avoided by buying reinsurance from other underwriters — unfortunately this often turns into another way for the savvy to fleece the ignorant.

IANAL and IANATA, but instead of an ordinary corporation you can form a limited liability company or an “S” corporation for special IRS rules to avoid this double taxation.

15

Really not much of an issue since money paid to you by the corp as an employee is a legitimate expense and deducted from corp taxable income as are your payroll taxes and SSI contributions. So they do not really get taxed twice on the same money.

16

dividends paid to you are also deducted before taxing the corp.

17

No. Dividends are not tax deductible to the corporation. There is some level of double-taxation with a C Corporation issuing dividends.

However, salaries are deductible, so many C Corporation owners pay themselves more in wages and minimize company profits that way.

18

Not sure in the USA - I assume tehre aer 51 different rules.

From the little bit I saw investigating this option once in Canada:
-the “owner” or responsible officer or whatever cannot pay himself a salary - it is essentially cash withdrawl from the business, treated as dividends. The tax on dividends paid and the income tax on dividends received work out the same.
-the tax regimen in Canada is such that personal service corporations are not any better tax-wise than not being incorporated; you save a tiny bit, but you blow that and more in legal and accounting costs.
-The only place where it is convenient is if the spouse or someone has a legitimate job helping out with the company’s work and so you can pay them a salary.
-Canada does not allow personal service corporations to accumulate cash beyond what is needed to “run the business”. You can’t treat a corporation as a 401K /RRSP type of cash accumulation and longer term income averaging tool.
-there are also a number of special rules to prevent someone using a personal service corporation to simply avoid payroll taxes (Canada pension plan and unemployment insurance). In the end the cost is no different.

keep in mind that Revenue Canada and the IRS have seen every trick in the book, and fixed the rules accordingly - for the average person it’s almost impossible to “beat the system”.

19

This wouldn’t work for two reasons:

  1. Just because you are driving for business doesn’t mean that you aren’t personally liable. You and your employer are both liable under respondeat superior. In practice, most people simply go after the business because it is the higher insured/ deeper pocket, and they can get full satisfaction from them. But if your “business” is a shell corporation with no assets, the victim is coming after you for their money.

  2. If the evidence shows that your LLC is wholly owned by you, and serves no real purpose except to allow you to drive to bars, a lawyer will likely pierce that veil and determine that you are simply using the LLC as your agent, and as such, you will be responsible for the torts of the LLC.

YMMV.

20

Are lawyers and accountants still required to operate as partnerships in at least many US jurisdictions?

On a Law Firm’s letterhead, there is a list of peoples names in the upper left corner. When present, the horizontal line between names indicate Partners (above the Line) and Associates (below the line). Or so I was told by a person at a party who worked for a law firm. Of said she did.