The Consequences of Noncompliance in Business

Business compliance is a phrase that makes many an entrepreneur cringe. But despite the lack of affection for those two words, business owners must take them seriously. The possible consequences for noncompliance range from mild inconvenience to devastating disaster. Most critical is that noncompliance by Limited Liability Companies and Corporations can lead to piercing the corporate veil, which puts business owners’ personal assets at risk.

Before I get into the penalties for noncompliance, let’s first take a moment to discuss what it is exactly.

What is Noncompliance in Business?

Nearly every business has rules, regulations, and standards to uphold to operate lawfully. The requirements exist to protect the company, employees, stakeholders, and customers. Compliance obligations vary according to the industry, location of the business, business activities, and entity type.

Noncompliance refers to when a business fails to fulfill its compliance requirements.

Depending on the business, corporate compliance may entail obeying safety guidelines, ensuring customer privacy (e.g., health care practices and HIPAA), properly handling payment of wages and salaries to employees, paying taxes, maintaining proper licensing, holding shareholder meetings, and complying with all other local, state and federal laws.

Businesses in highly regulated Industries like the examples below, face more and stricter compliance requirements than companies in other industries:

• Health care and Medical
• Financial
• Construction
• Energy
• Transportation

In this article, we’re going to discuss noncompliance mainly as it relates to business entity types since it’s impossible to cover every industry and business activity.

Compliance Requirements by Entity Type

Business structure affects the filings, reports, and other formalities a company must carry out to legally conduct business. Every state has its own rules, and counties and local municipalities may have regulations, as well. To give you a general idea of what different business structures have to do to stay compliant, I’m going to list compliance formalities by entity type.

Sole Proprietorship and Partnerships

Sole Proprietorships and Partnerships are considered the same entity as their owners (both legally and from a tax perspective). So, there are no corporate compliance formalities to maintain them. However, that doesn’t mean that entrepreneurs operating as Sole Proprietorships or Partnerships don’t have rules to follow to run their businesses legally! Some of the things that individuals running their businesses as Sole Proprietorships and Partnerships must do include:

• File for and renew their fictitious name (Doing Business As) if they are marketing their business under a name other than one that includes their first and last name
• File their personal income tax returns (business income is reported on IRS Form 1040 Schedule C) and pay applicable income tax and self-employment tax
• Apply for and renew any required business licenses and permits
• Collect and remit sales tax (if required for the products and services they are selling)
• Obtain an EIN (Employee Identification Number), if hiring employees
• Abide by all employment and labor laws (if the business has employees)

Limited Liability Companies (LLC)

A Limited Liability Company is considered a separate legal entity from its owner(s) (called members). The LLC structure gives members some protection against the legal and financial debts of the business. However, from a tax perspective, an LLC and its owner(s) are treated as the same entity. In other words, taxes flow through to owners’ personal income tax forms.

Some of the compliance requirements LLCs must usually fulfill include:

• File Articles of Organization to establish the entity with the state.
• Appoint and maintain a registered agent
• Obtain an Employer Identification Number (EIN)
• File an initial report and annual reports
• Create an LLC operating agreement to put forth the company’s major decision-making and operating procedures (generally, it’s not required by the state, but it helps ensure other compliance requirements are addressed properly)
• Issue member shares and record interest transfers
• Hold LLC member meetings (also, prepare minutes and have all members sign to approve them)
• File their income tax returns and pay applicable income tax (business income is reported on IRS Form 1040 Schedule C) AND self-employment tax)
• Apply for and renew any required business licenses and permits
• Collect and remit sales tax (if required for the products and services they are selling)
• Abide by all employment and labor laws (if the business has employees)
• Maintain a bank account solely for business activities, so you do not commingle business and personal financial activities and funds
• File Articles of Amendment to report any significant business changes

C Corporations

A C Corporation is a separate legal and separate tax-paying entity from its owners (called shareholders). With more stakeholders and a higher degree of liability protection for owners and directors, Corporations have stricter compliance requirements than other business entities.

Below are examples of what C Corporations may need to do to satisfy their compliance obligations:

• File Articles of Incorporation to establish the entity with the state
• Appoint and maintain a registered agent
• Obtain an EIN (Employer Identification Number)
• File an initial report and annual reports
• Adopt corporate bylaws to put forth the company’s major decision-making and operating procedures
• Apply for and renew any required business licenses and permits
• Appoint and maintain a board of directors
• Hold board of directors meetings (also prepare minutes afterward, and have all directors sign to approve them)
• Hold annual shareholder meetings (also prepare minutes and have all directors sign to approve them)
• Pay income taxes and file corporate tax returns
• Collect and remit sales tax (if required for the products and services sold)
• Issue stock to shareholders and record stock transfers
• Abide by all employment and labor laws (if the business has employees)
• Maintain a bank account solely for business activities. Do not commingle business and personal financial activities and funds
• File Articles of Amendment to report any significant business changes

S Corporations

An S Corporation is not a type of business entity but rather a special tax election that eligible LLCs and Corporations may choose. Generally, S Corporation requirements follow what the underlying entity (LLC or Corporation) must fulfill.

Consequences of Noncompliance

Now that we’ve discussed some of the typical compliance requirements, let’s get into what could happen when businesses do not follow the rules. The severity of penalties varies, and they often depend on the seriousness of violations. For any business, noncompliance can cause big problems!

Here are some of the possible consequences of noncompliance:

• Piercing of Corporate Veil – I mentioned this at the start of this article, and I’ll expand on it here. The corporate veil (also called a corporate shield) is the legal distinction between an LLC or corporation and its owner(s). It is the legal separation established by keeping a company’s activities, assets, and liabilities independent from those of the business owner(s). If an LLC or Corporation fails to fulfill its compliance requirements, a court might decide that the corporate veil has been pierced and that the individuals who own or oversee the business are personally accountable for the debts or legal wrongdoing of the company.
• Audits – Noncompliance draws closer inspection of a business’s processes and financials. No one likes to hear the word audit. That’s no wonder because audits demand a lot of time and money as business owners and employees get pulled away from doing revenue-generating work.
• Financial penalties – Noncompliance can hit a business’s checking account hard. There may be fines, back taxes, interest, and other financial penalties levied if a company fails to fulfill its compliance requirements.
• Suspension or termination of the business – If the frequency or severity of noncompliance warrants it, a company may fall out of good standing with the state and be forced to either suspend operations or close its doors entirely. Stating the obvious, this can be fatal for a business.
• Imprisonment – The LLC and Corporation business entity types provide some liability protection to owners and directors. However, noncompliance may lead to civil or criminal prosecution of owners, officers, and directors if their personal actions were unlawful or negligent.
• Damaged brand reputation – As word gets out publicly about a company’s noncompliance, it could permanently hurt the business’s reputation. That could destroy customer and vendor confidence as well as make lenders wary of providing financing to the business in the future. The hit to a brand’s reputation can destroy trust in the company and limit future opportunities.

How to Stay Compliant

For some businesses, the compliance requirements may be numerous and complex. Entrepreneurs must understand their obligations so that they don’t suffer the consequences we covered above—especially the increased legal risks associated with piercing the corporate veil. To accomplish that, I recommend seeking professional legal and accounting expertise.

Also, consider using CorpNet’s Compliance Portal. Different states have different deadlines. With CorpNet’s Compliance Portal, you can track your business filing requirements in all of the states where you conduct business.

Something else that can help you immensely is to designate CorpNet as your registered agent to receive all critical government and legal notices on your behalf. We provide registered agent services in all 50 states. As your registered agent, we ensure that you know when your business entity’s vital compliance deadlines are approaching.

But that’s not all that we can do!

To make compliance even easier for you, we can also prepare and submit your business filings and reports for you.

Yes, business compliance can be complicated, and the consequences of noncompliance are scary. With CorpNet’s help, however, you don’t have to sweat the small stuff (or the big stuff!). Contact us today to learn more about how we can help your business stay compliant.