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.
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.