Dissolution of the corporation
Corporations are creatures of state law. The state decides what is required before a corporate charter will be issued. And, what the rules are for maintaining the corporate charter. Having a corporation provides shareholders a lot of benefits. Typically, shareholders are not personally liable for corporate debts, taxes, or other financial obligations. Shareholders cannot be sued for the actions of the corporation.
Florida requires that corporations file an annual report every year. If a report is not filed by the third Friday in September, the company may be dissolved by the state.
This puts all of the corporation’s assets at risk and could put the shareholders in financial and legal jeopardy.
The law also requires that corporations have annual shareholder meetings and that the company keeps notes of the meetings.
Failure to comply with these requirements could cause the state to dissolve the corporation or to revoke the corporate charter, which in effect would mean that the corporation never existed.
These drastic consequences are easy to avoid if corporate records are properly maintained and all corporate formalities are properly observed.
Piercing the corporate veil
One of the most severe consequences of corporate maintenance and compliance failure is the piercing of the corporate veil. This means that a court has decided that the corporation is not a true company, but is instead just a sham to try and hide assets from creditors.
When a judge allows for the piercing of the corporate veil it opens up shareholders to being personally liable for the debts of the corporation. It also removed legal protections that kept the shareholders and officers from being sued individually for the actions taken by the corporation.
The piercing of the corporate veil renders all of the financial and legal protections of the corporation useless. It also effectively ends the life of the corporation.
Courts are usually reluctant to pierce the corporate veil. However, when companies have failed to properly maintain their corporate records and hold the required meetings, it is easier for courts to pierce the corporate veil and to allow plaintiffs and creditors to personally sue corporate officers and shareholders.
When the IRS performs a corporate audit one of the things they are interested in is making sure that the corporation is a real company and not part of a tax avoidance scheme. This is especially important in closely held companies.
When there are no corporate records, or the minutes of meetings are vague and irregular, the IRS may get suspicious. If the IRS finds that the corporation has not been holding the appropriate meetings or keeping the appropriate records, it may find that the corporation doesn’t count as a corporation for tax purposes.
This will have several devastating consequences. First, it can open up shareholders to personal liability for the tax debts of the company. The IRS has sweeping powers to garnish accounts, place tax liens on homes and cars, and to seize assets to pay tax debts.
A finding by the IRS that the corporation is a sham, could expose previous years’ corporate tax returns to review. The shareholders may lose the tax benefits associated with owning a company. Money that was once taxed at capital gains rates may be taxed at the much higher personal income tax rates.
If the IRS finds that the corporation is a sham, it is the officers and shareholders that will feel the brunt of the IRS’s tax enforcement practices.
Exit strategy issues
If you ever want to sell your business or to merge with another company, part of the other side’s due diligence will be to lookup your annual reports and to survey your corporate records.
If you are not able to produce timely, full and accurate corporate records, it may be a red flag to your potential partner or buyer. They may decide that doing a transaction with you is too risky and could call off the deal.
They may also decide that because of the risks created by your poor corporate record keeping they will only proceed with the deal at a greatly reduced price.
Few companies will be willing to assume your debts if your assets may be vulnerable to attack from plaintiffs because of poor record keeping practices.
Until you can sort out your corporate records and compliance issues you may be left without a clear exit strategy from your business.