Compliance Requirements and Consequences
After the initial step of formation, both corporations and LLCs face ongoing compliance requirements; however, business owners, especially small business owners, often neglect these requirements. Whether the excuse is not knowing about them or not having time to address them, not satisfying these requirements is a big mistake.
Failing to complete ongoing requirements regularly and in a timely manner can have dire consequences. A company can lose its corporate or LLC entity status, and consequently lose the limited liability protection it affords the owners. Given that limited liability protection is often the primary reason business owners form a corporation or LLC, an owner should take all the necessary steps to protect it and the other benefits corporations and LLCs afford.
The Requirements
The requirements can be grouped into two categories: internal and external. Internal requirements are actions that must be taken within the corporation or LLC by the directors and shareholders or members and managers respectively. These actions must be documented and those documents kept with the company records. External requirements are those imposed on corporations and LLCs by the state in which they are formed or foreign qualified. These requirements often include an annual state filing and payment of a corresponding state fee.
Internal requirements are those most commonly overlooked. A Corporation has the strictest internal requirements, including holding initial and annual meetings of directors and shareholders, adopting and maintaining updated bylaws, issuing stock to shareholders, and recording any subsequent stock transfers. While for an LLC it is not required, it is still recommended to adopt and maintain an updated operating agreement, issue membership shares, record any subsequent interest transfers, and to hold annual meetings of the members or managers.
Many business owners use a Corporate kit or LLC kit for organizing records. These kits include items such as sample bylaws or an operating agreement, stock or membership interest certificates and transfer ledger, a corporate or LLC seal, and sample meeting minutes.
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For external requirements, most states require corporations and LLCs to file an annual statement or annual report. Annual statements allow states to keep updated information on corporations and LLCs formed or qualified there. Because certain information included in the articles of incorporation or articles of organization does not require an amendment to update, such as the names and addresses of the directors of a corporation or the members or managers of an LLC, the states rely on updated information in the annual statement.
While most states require annual statements, some states have a biennial statement. In either case, the states typically require a fee be paid when these statements are returned to the state. These fees vary by state and often by entity type and can range from under $10.00 up to over $300.00.
Some states also have a franchise tax, which is essentially a fee paid to the state for the mere privilege of operating as a corporation or LLC formed or qualified in that state. The states employ different formulas for calculating the franchise tax. For example, the tax may be based on the corporation’s or LLC’s revenue or a corporation’s number of authorized shares and par value.
The due dates for annual statements and franchise taxes vary by state. Some states connect these due dates to the anniversary of the corporation’s or LLC’s formation or qualification. Other states set a particular due date for all corporation annual statements and another for all LLCs. Because the annual statements and franchise taxes represent ongoing requirements corporations and LLCs will face, it is advisable for business owners to research these requirements prior to incorporating, so that they know what to expect going forward, and can attempt to budget for the cost.
The Consequences
If a corporation or LLC is sued and unable to show it indeed has met all of the corporate or LLC formalities and state requirements, a judge can rule that the company has been acting more like a sole proprietorship or general partnership. This can result in what is called“piercing the corporate veil.” When the corporate or LLC veil is pierced, the limited liability protection of the entity disappears and the assets of the individual owner(s) are now accessible should a lawsuit judgment be made against the company.
There are also consequences on the state level that can happen prior to piercing the corporate veil. When a corporation or LLC does not comply with a state’s annual or ongoing requirements, that company is no longer in “good standing” with the state.
Each state has different parameters for what is required before a company falls out of good standing and also how the states handle it. For example, many states impose late fees and interest payments on the outstanding annual statement and/or franchise tax fees.
Being out of good standing long enough may lead to administrative dissolution by the state. When the state administratively dissolves a corporation or LLC, all of the benefits of being a corporation or LLC are lost. In these instances, companies must be reinstated.
Compliance Assistance
There are a number of tools available today, such as online compliance management tools, many specifically geared towards small business owners, to help make the process of complying with both internal formalities as easy and convenient as possible. If you took the time to form your business as a corporation or LLC, you should also take the time to ensure it stays compliant and keeps its valued entity status.
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