What is the concept of being personally responsible for all debts of a business?

Unlimited liability is when one or more individuals are liable for their company’s taxation and debts. In this regard, it is very different to a limited liability company (LLC). The latter is designed specifically to insulate individual LLC members (partners or stakeholders) from risk.

As such, no single person’s assets are affected if the company fails, gets sued or owes a debt. In a limited liability company or partnership, business partners are only liable for the amount of money they have put into the company.

In an unlimited liability company, the owner is inextricable from the business and is personally accountable for the company’s liabilities. This also means that they are entitled to the company’s profits after taxes.

However, if the business owes a debt it is unable to pay with company funds, the owner(s) will be personally liable. As such, their personal wealth or assets may be seized to cover the debt, especially if it is owed to HMRC or the IRS.

In the UK, an unlimited liability company is created under the Companies Act of 2006.

Examples of unlimited liability

The primary example of an unlimited liability company is a sole trader or sole proprietorship – an unincorporated business structure where one individual is responsible for the company. Sole traders often work as contractors or subcontractors in fields like construction or creative media.

Sole proprietorship encompasses a wide range of individuals from plumbers and electricians to graphic designers and copywriters. Sole proprietorships can, however, still hire employees without needing to change their corporate structure.

However, a partnership can also be an unlimited liability company. The liability is shared between the partners unless the partnership is a limited liability partnership.

In Canada, an unlimited liability corporation allows shareholders (and ex-shareholders) to be liable if the company is made bankrupt.

Which is the best type of business structure for your company?.

Pros and cons of unlimited liability

Unlimited liability companies are often sole proprietorships which are easy to set up and dismantle, affording business owners greater autonomy.

Unlimited companies are also not required to disclose their financial records in the same way as their limited counterparts. This non-disclosure could have tax advantages depending on the size of the company’s profits.

Generally, companies with unlimited liability are subject to fewer compliance regulations, and sole traders can retain all of their profits after tax has been deducted. However, the benefits of unlimited liability come with some clear caveats.

Having personal liability for company debts could add stress to the existing complications that come from running a business, and this may prove devastating if the individual has to use their own assets to pay a large company debt.

What’s more, because they generally involve a greater degree of risk, companies with unlimited liability may find it harder to secure funding.

Frequently asked questions about unlimited liability

How are companies with unlimited liability taxed?

Companies with unlimited liability are taxed according to their business structure. Sole traders pay income tax on their profits. Sole traders in the UK also pay National Insurance contributions on the profits they make. Similarly, partners are taxed on their individual share of the profits for each financial year.

Should I choose a limited or unlimited liability business structure?

If you’re looking for a simpler life with less paperwork, an unlimited liability company may be more appealing. This means annual accounts and financial reports do not need to be prepared and shared with the public.

However, with an unlimited company comes a greater degree of personal risk. You should structure your company as a limited liability business entity if you believe the business faces a high risk of insolvency.

One of the first steps that an entrepreneur must complete in order to start a business, is to decide which business structure they should choose. There are four primary business structures: Sole Proprietorship, Partnership, Corporation, or Limited Liability Company. This article will provide a brief introduction to the sole proprietorship. Future articles will introduce the other business structures.

Overview:

The term “sole proprietorship” is used to describe a business that is owned and operated by one person who is referred to as the sole owner or sole proprietor. For legal and tax purposes, the business does not have its own identity. The sole owner and the business are considered one in the same. Sole proprietorships are popular because they are the easiest and most inexpensive business structure to set up.

Formation:

In Iowa, sole proprietorships are not required to file organizational documents with the Iowa Secretary of State. To create a sole proprietorship, the sole owner must decide whether to operate using their personal name or to assume a business name. If a business name will be assumed, the owner must file a trade name filing with the county recorder in the county where the business is located. If the business will operate using the owner’s personal name, no county filing is required.

Tax Responsibilities & EIN:

Sole proprietorships do not need to file business tax returns, instead business profits or losses need to be reported on the sole owner’s personal tax return. Similarly, sole proprietors do not need to acquire an Employer Identification Number (“EIN”) unless they will hire employees. All businesses with employees are required to report wages to the IRS using their EIN. A sole proprietor without employees can use their own social security number for most things that an EIN would be used for. Some sole proprietors without employees prefer to acquire an EIN in lieu of using their own personal social security number.

Unlimited Liability:

Sole proprietorships do not have the protection of limited liability. Instead, the sole owner has unlimited liability. This means that the sole owner is personally liable for the debts and expenses of the business. If the business is sued, the sole owner risks losing their personal assets. To help protect their assets, a sole proprietor should consider obtaining a business liability insurance policy.

Additional Considerations:

Depending on the specific business activities, a sole proprietor may be required to report and pay certain taxes which are not discussed above, such as sales tax and use tax. The sole proprietor may also need to obtain licenses or permits.

Please contact any of our business formation and startup attorneys if you would like additional guidance regarding this topic or assistance forming a business entity.

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