The Third Circuit seems to think that shareholders of corporations that elect to be taxed as S Corporations have no limited liability. The good news is that the bizarre language to this effect is not relevant to the decision and therefore should not be treated as governing law or given any precedential value.
The bad news is that plaintiffs may raise this language like a flag and charge ahead, and worse yet, the Third Circuit and other courts may very well adopt this language as if it is the law. The facts of the case are not that important. In its decision, the court stated:
“In addition, we find it relevant that “Pat’s Restaurant of Cameron, Inc.” is a Chapter S corporation. The owners of such qualifying entities are taxed as sole proprietors or partnerships and are personally liable for the losses and debts of such a corporation; the Chapter S corporation is not taxed. See 26 U.S.C.A. §§ 1363, 1366. Under Louisiana law, this corporation, therefore, is not a separate and distinct entity from the individual, Doland, and as a result, there exists no legal distinction between the individual and the business. See Robinson v. Heard, 01-1697 (La.2/26/02), 809 So.2d 943.” (emphasis added)
We are not sure why the Robinson case is cited as it involved a sole proprietorship, not a corporation. Because many closely held corporations elect to be taxed as S Corporations, this language is very troubling. Furthermore, this logic would also apply to those limited liability companies that elect to be taxed as S Corporations, partnerships and disregarded entities further expanding the potential scope of this concept. The owners of all of these entities anticipate being afforded the protection of limited liability but unfortunately more and more courts are getting lost on this issue.