Unlimited liability is when one or more business owners or partners are liable for their company’s debts and tax compliance. It is very different to a limited liability company (LLC), whose business structure is designed specifically to insulate individual partners or stakeholders from risk.
In an LLC or partnership, business partners are only liable for the amount of money they have put into the company. With unlimited liability, an individual’s assets are affected if the company fails.
An unlimited liability company (ULC) is, for financial and tax purposes, inextricable from its owner. The owner is personally accountable for the company’s liabilities, but is also entitled to the company’s profits after taxes.
In the US, a ULC is referred to as a hybrid company. It is an incorporated entity with unlimited liability. That said, a ULC shelters individual shareholders from liability in most circumstances. The primary exception, however, is if the company should be liquidated. Even former shareholders in a ULC can be liable for the company’s debts, in this case, if they sold their shares less than one calendar year before the company was made bankrupt.
In Canada, an unlimited liability corporation allows shareholders and ex-shareholders to be liable if the company is made bankrupt and goes into liquidation.
Examples of unlimited liability
The primary example of a ULC is sole proprietorship. Sole proprietors often work as contractors or subcontractors in fields like construction, or the media.
Sole proprietorship encompasses a wide range of individuals from plumbers and electricians to graphic designers and copywriters. A sole proprietorship can still hire employees without needing to change its corporate structure. Many small retailers like “mom and pop” stores are structured as sole proprietorships.
A partnership can also count as a ULC in which the liability is shared between the partners, unless the partnership is an LLC.
Pros and cons of unlimited liability
A ULC is often a sole proprietorship which is easy to set up and dismantle. It also provides the business owner greater autonomy to run the company as they see fit. An unlimited company is also not required to disclose its financial records in the same way as its limited counterparts. This non-disclosure could have tax advantages depending on the size of the company’s profits.
Generally, a company with unlimited liability is subject to fewer compliance regulations, and a sole trader 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; this may prove devastating if the individual has to use their own assets to satisfy creditors if the company goes into liquidation.
What’s more, because it generally involves a greater degree of risk, a ULC may find it harder to secure business loans.
Frequently asked questions about unlimited liability
How is a ULC taxed?
In the US, a ULC is treated as a pass-through entity for tax purposes, thus avoiding the double taxation that can come with other forms of incorporation.
Should I choose a limited or unlimited liability business structure?
If you’re looking for a simpler life with less paperwork, a ULC 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 if the company goes bankrupt. You should structure your company as a limited liability business entity if you believe the business faces a high risk of going into liquidation.