You formed the LLC because you didn’t want a business lawsuit to take your house. Smart move. The protection is real — but it comes with conditions.
When those conditions aren’t met, a court can set the LLC aside entirely and hold you personally liable for what the business owes. This is called piercing the corporate veil, and it happens more often to small business owners than to larger companies. The reason is simple: small business owners are more likely to treat the business like an extension of themselves.
What “Piercing the Veil” Actually Means
The legal protection an LLC gives you exists because the company is a separate legal entity from you. Separate assets, separate debts, separate obligations. When a creditor or plaintiff sues your business and wins, they can generally only go after business assets — not your personal bank account, your home, or your car.
Veil piercing is when a court decides the LLC isn’t actually separate from you. That it’s just your alter ego. When that happens, the separation disappears and your personal assets are on the table.
In New York, courts apply a two-part test: first, was there “complete domination” — did you use the LLC as an instrument of yourself rather than treating it as a real, independent entity? Second, was that domination used to commit some fraud or wrong that caused harm?
Recent New York case law has taken a somewhat expanded view of the second prong — courts don’t necessarily require outright fraud anymore, just some kind of inequitable result. That’s a lower bar than it sounds, and it should get your attention.
The Behaviors That Get Owners in Trouble
Commingling funds. This is the most common trigger. You use the business account to pay your personal credit card. You deposit a client check into your personal account because it was convenient. You run a car payment through the LLC. Once that pattern exists, you’ve handed a plaintiff the argument that your LLC and your personal finances are the same thing.
I’ve written about how commingling creates IRS audit risk. But the audit problem and the lawsuit problem are separate. You can have both at the same time, and they each have their own consequences.
Starting with no real money. “Undercapitalization” is the technical term. If you form an LLC with $100 in the bank, take on significant liabilities, and the company later can’t pay its debts — a court may find that you never intended for the LLC to be a real, independent business. There’s no specific number required, but the capitalization should be reasonably proportional to the risks and obligations of the business.
Ignoring what’s on paper. Multi-member LLCs should have an operating agreement, and those agreements should be followed. If you’ve got two members but one person makes all the financial decisions without documentation, that’s a formality problem. It doesn’t take much — the argument a plaintiff makes is that if you didn’t treat the LLC like a real entity, the court shouldn’t have to either.
Using business assets for personal purposes. Business vehicle used primarily for personal trips. Business credit card used for personal expenses. Business funds used to remodel your home. Each of these erodes the separation between you and the entity.
If you're not sure whether your LLC is operating as a true separate entity — or if you just formed one and want to set it up right — let's talk. Getting the structure right from the beginning is easier than fixing it after a lawsuit.
A Note on Single-Member LLCs
Single-member LLCs face higher veil-piercing risk than multi-member entities. Courts look closely at them because the overlap between owner and company is more obvious. The IRS also disregards single-member LLCs for federal tax purposes by default — they’re “disregarded entities” — which creates some additional confusion about what’s truly separate.
That doesn’t mean a single-member LLC is worthless. It means you have to be more disciplined about how you operate it.
What Actually Keeps Your Protection Intact
The good news is this is all preventable. None of it requires expensive lawyers or complicated systems.
Dedicated business bank account. One account, only for the business. Every business payment goes in and out of it. If you need to take money out personally, it’s a documented distribution or a payroll payment — not a transfer to cover your mortgage.
Capitalize the business adequately. Put enough money in to cover foreseeable obligations. If the business is taking on a significant contract, a lease, or liability exposure, the capitalization should reflect that.
Document distributions. When you take money out of the LLC, it should be a formal distribution, not just an ATM withdrawal. For multi-member entities especially, distributions should follow what the operating agreement says.
Keep the paperwork current. Operating agreement, member resolutions for major decisions, separate accounting records. These things exist so that if your entity is ever challenged, you can show a court that you ran it as a real business.
The Reason to Do It Right
Forming an LLC without maintaining the formalities gives you false comfort. You have the filing fees and the entity name, but not the protection. Courts are looking for evidence that the LLC was a real, independent thing — and the evidence is in how you actually ran it.
If you’re thinking about entity structure, or you’re not confident yours is set up to actually protect you, start with How to Choose a Business Structure and the LLC vs. S-Corp Calculator. The structure question and the operational question are both worth getting right.
Questions about whether your LLC is set up to give you real liability protection? That's a conversation worth having before there's a problem, not after. My office is available for consultations.
This post is for general information only and does not constitute legal or tax advice for your specific situation. Liability protection rules vary by state and are determined by courts on a case-by-case basis. Consult a qualified attorney and tax professional before making decisions about your business structure.