Are You Considering a Business Partnership?

If your business will be owned and operated by more than one individual, structuring as a partnership may be the best way to go. There are two types: a general partnership and a limited partnership.

Read more

Commercial Landlord Tenant Law

Under Florida law, both commercial landlords and tenants have rights and responsibilities. It is important to understand the legal process as it affects this type of business relationship. The rights of both parties depend largely on what is in the rental agreement. Read more

Do I Need a Lawyer to Review my Non-Compete Agreement?

Has an employer presented you with a non-compete agreement?  If your employer has asked you to sign a non-compete, you should know what rights you are relinquishing. Read more

Temporary & Preliminary Injunctions

After the filing of a lawsuit, a party can ask the judge to issue a temporary injunction.  The temporary injunction seeks to require the other party to either commit a certain act or to prohibit it from performing a particular action.

In a business or commercial law context, injunctions are often sought to enforce a non-compete agreement.  A non-compete agreement is a standard business agreement to prevent an employee from competing against his former employer after departing from the company. A temporary injunction can be obtained ex-parte (without notice and hearing to the other party) until an evidentiary hearing can be held for a possible preliminary injunction.  The preliminary injunction is usually valid until trial.

In order to receive a preliminary injunction, Plaintiffs need only show that: (1) it has a substantial likelihood of success on the merits; (2) irreparable injury will be suffered unless the injunction issues; (3) the threatened injury to the movant outweighs whatever damage the proposed injunction may cause the opposing party; and (4) if issued, the injunction would not be adverse to the public interest.

Under Florida law, both of these injunctions are designated as a temporary injunction.  Additionally, the applicable Florida statute states that “No temporary injunction shall be entered unless the person seeking enforcement of a restrictive covenant gives a proper bond, and the court shall not enforce any contractual provision waiving the requirement of an injunction bond or limiting the amount of such bond.”


Creditors of a Florida single member LLC (“SMLLC”) are able to reach the assets of SMLLC by obtaining a charging order and then foreclosing on the member’s interest.  However, if an LLC has multi-members, creditors are limited to distributions that a debtor member would ordinarily receive from the LLC.

To prevent a foreclosure of a SMLLC interest, an option is to initially form the LLC with a spouse having a member interest.  The spouse would be entitled to distributions proportionate to his/her respective interest and the creditor would be limited to those distributions.

Since Florida is a non-community property state, a LLC owned by a husband and wife would then be deemed a partnership for IRS purposed and should file its returns accordingly.

However, each spouse would now be potentially personally liable for various federal and state taxes; along with judgments from creditors.  Whereas a SMLLC would limit any personal risk exposure to one spouse, the liability exposure of the other spouse in a multi-member LLC would negate the advantage of forming a LLC to minimize personal liability.

It might be wise to stick with a SMLLC and acquire an umbrella insurance policy to address any unforeseen contingencies.


A noncompete agreement is a standard business agreement to prevent a former employee from competing against you upon his departure from the company. When such an agreement is not in place, employers have to scramble for a solution to prevent the former employee from disclosing confidential information to the new employer. In particular, litigators are using the inevitable disclosure doctrine to stop the former employee from working for the competitor because confidential information will inevitably be disclosed. Across the country, and in Florida, courts are reluctant to apply this doctrine unless there is some bad faith conduct. Prevailing under this theory is unlikely and it should be used when there is no noncompete agreement in place.


Derek P. Usman, The Usman Law Firm, P.A.


After making the decision to dispose of a corporation, entrepreneurs and business owners should consider tax consequences and plan accordingly. Often, an exit strategy utilized by a private corporation is the acquisition of the corporation by a public company whose shares are readily saleable because they have a public market. Under this scenario, the target corporation is merged into the acquiring corporation with the target’s shareholders receiving the buyer’s (or acquiring corporation) stock. The transaction qualifies as a reorganization under section 368(a)(1)(A) of the Internal Revenue Code of 1986 which provides that “the term ‘reorganization’ means a statutory merger or consolidation.”


Code section 368 reorganizations allow target corporation shareholders to exchange target stock for buyer corporation stock without gain recognition. The acquisition would be tax free to the target corporation and its shareholders when the transaction satisfies the requirements of one of the paragraphs of section 368(a). Even though section 368(a) describes several different forms of reorganization, the statutory merger effected under state corporate law is the easiest of the subsections under which to qualify. Furthermore, this statutory merger or consolidation under section 368(a)(1)(A) is commonly referred to as an A Reorganization. The A Reorganization allows the use of up to 60 percent of consideration in the form on non-stock, e.g., cash (“boot”). Additionally, a transaction qualifies for A reorganization treatment irrespective of whether the target corporation retains substantially all of its assets, and whether or not the acquiring corporation issues voting or non-voting stock to the target shareholders.


Similar to an A Reorganization, a B Reorganization under section 368(a)(1)(B) also involves an exchange of stock for stock but prohibits the use of boot altogether. While a C Reorganization (section 368(a)(1)(C)), a stock for assets acquisition, generally limits boot to 20 percent of total consideration. Therefore, the structure of a transaction will determine which particular reorganization provisions are applicable. For example, as just mentioned, the presence of boot would not qualify a transaction as a B Reorganization.


In the merger, shareholders of the merged, or target, corporation, receive their “new” shares from the acquiring company tax free. The shareholders take a basis in the new shares they receive equal to the basis that had in their old shares. Therefore, any tax on the disposition is deferred until sale of those shares.


Target corporation shareholders may determine tax basis in buyer stock using a tracing method. Under the tracing method, shares of new stock may be designated as having been received in exchange for particular blocks of target stock. This allows the target corporation shares purchased at a higher price, than other target corporation shares, to be “traced” to buyer shares received in an exchange. Therefore the higher basis share are sold first. Alternatively, under an “averaging method”, a shareholder’s basis in target shares would be spread pro-rata to the newly received shares.


The ability to sell the new shares on a piecemeal basis allows the shareholders to have liquidity and diversification in their investment. Also, as mentioned previously, if the target company’s shareholders receive some cash (within the statutory constraints to qualify for reorganization treatment), the shareholders will recognize gain to the extent of the cash received.


Since, a shareholder recognizes gain to the extent of cash or property (other than stock or securities), the proper treatment of the boot should be considered. Under 356(a)(2), the recognized gain will be ordinary income (to the extent of the shareholder’s undistributed share of the target corporation’s earnings and profits), if the boot received has the effect of a dividend.


The IRS in Rev. Rul. 93-61 has stated that it would follow Clark, 489 US 726 (1989) in determining the treatment of boot as ordinary income or capital gain. Specifically, in acquisitive reorganizations, the treatment of the boot as ordinary income or capital gain should be resolved by comparing the interest the shareholder actually receives against the interest that would have been received if only stock and no boot was involved.


Here’s some numbers to make things a little simpler. The shareholder of a wholly owned corporation receives an offer, consisting of two choices, by a publicly held corporation to purchase the private corporation. The publicly held corporation offers the choice of 425,000 shares of its stock or 300,000 shares plus $3,250,000 cash. The shareholder chose the stock plus the cash. In Clark, the Supreme Court analyzed the transaction by asserting that, first, the shareholder exchanged all of the shareholder’s shares for 425,000 shares of stock in the publicly held corporation. Next, the shareholder is deemed to have had 125,000 shares redeemed for $3,250,000 in cash. The portion of the transaction involving the 125,000 shares has to meet the requirements for a redemption to qualify for capital gain treatment (a meaningful reduction of the shareholder’s interest and thus a redemption not essentially equivalent to a dividend). Otherwise, the boot is designated as a dividend and thus, ordinary income to the extent of any accumulated earnings and profit of the target corporation.


Still yet, to qualify as a reorganization under section 368(a), a transaction must satisfy the continuity of business enterprise requirement. Section 1.368-1(d)(1) requires that the acquiring corporation either continue the target corporation’s historic business or use a significant portion of the target’s historic business assets in a business for a reorganization to satisfy the continuity of business enterprise requirement. Nevertheless, the doctrines underlying the continuity of business enterprise requirement are easy to satisfy.


Of the various codified reorganization choices, an A reorganization is a popular way to structure the transaction for income tax planning purposes. The principal benefit of having a transaction meet the requirements of a type A reorganization is the deferral of income taxes. Similar to other exchange provisions of the Internal Revenue Code, a shareholder’s existing basis is carried over to the stock received. By utilizing the reorganization exit strategy, business owners are able to sell their business while deferring their gain.


Derek P. Usman, The Usman Law Firm, P.A.


The statutory provisions providing limited liability to shareholders of Illinois business entities were undermined recently when the Illinois Supreme Court endorsed “direct participation” as a viable theory of tort liability under Illinois law. In Forsythe v Clark USA, Inc., 2007 WL 495292 (Ill. Sup. Ct.), our state’s Supreme Court considered whether a parent company could be held liable under a theory of direct participant liability for controlling its subsidiary’s budget in a way that led to a workplace accident. Subsequently, the court recognized that the parent company’s “participation” in the subsidiary’s conduct could subject the parent to direct liability. Even though Illinois statutes permit separate incorporation for the purpose of limiting liability, the direct participation theory may now be used to eliminate the protection of limited liability for a parent (or affiliate).


Justice Garman’s opinion in Forsythe concluded that evidence of budgetary mismanagement, accompanied by the parent’s negligent direction or authorization of the manner in which the subsidiary accomplishes that budget could lead to liability for the parent. Furthermore, the elements required under the direct participant theory are a parent’s specific direction or authorization of the manner in which an activity is undertaken and the foreseeability of injuries—budgetary mismanagement alone is insufficient. The court then remanded the case back to the trial court. (In the same opinion, the court also held that upon a finding of liability under the direct participation theory, the parent-defendant would not be protected by the exclusive remedy provision of the Workers’ Compensation Act available to the subsidiary because there is a direct action against the parent and not the subsidiary).


Under the court’s analysis, once the parent company directs or authorizes the manner in which an activity is undertaken, the company owes a duty of care to the plaintiff. The court explicitly asserted that this duty of care arises from policy-based factors courts utilize to determine the existence of a duty. Then the court stated that the corporation had a duty to utilize reasonable care in directing or authorizing the manner in which an activity is undertaken. Next, when the duty was breached, the breach was the proximate cause of the injury. Specifically, the court found that the corporation directed the implementation of the subsidiary’s budget in such a manner that there was a disregard for the interests of the subsidiary and dangerous conditions were created.


The Illinois Supreme Court is following other jurisdictions around the nation that have endorsed theories that erode limited liability for shareholders of business entities. Aside from the emergence of the direct participant liability theory in the Illinois legal landscape, Illinois entities need to be wary of a myriad of alternative theories that courts are upholding to erode the limited liability of incorporated businesses. These theories have been upheld not just in a tort context but contract situations as well. One such theory is termed “single business enterprise” where business connections, common ownership and various other means are utilized to establish that two distinct entities are operating in a coordinated manner. Seem familiar?


The primary purpose for the enactment of incorporation statutes is to insulate shareholders from unlimited liability for corporate activities. Upon reliance on these longstanding statutes and principles, holding corporations create subsidiaries as a common strategy to minimize risk for shareholders. These same shareholders are attempting the preservation of their investments by relying on laws that explicitly limit liability. Apparently, mandatory capitalization laws, insurance requirements, product safety requirements, etc. are deemed insufficient by courts that allow novel theories that undermine limited liability protection provided to shareholders of entities created under statutory authority.


The court in Forsythe has opened the door to utilize another theory, direct participation, to disregard corporate form and impose liability against a statutory entity. Still yet, let’s not forget the ever-popular veil piercing lawsuit. Cases raising veil-piercing issues are the most frequently litigated in all of corporate law and limited liability in Illinois is undermined whenever a veil piercing lawsuit is initiated. As a starting point, Illinois courts may look at as many as eleven factors before piercing the veil. A renowned commentator on the erosion of limited liability has stated that the list of possible factors used in veil piercing cases is aimed at satisfying particular public policy goals. Similarly, the furtherance of public policy aims is also a significant consideration underlying the adoption of the direct participation theory by the court in Forsythe. However, a recurring problem is that later judges often capriciously modify (if remember at all) public policy aims.


Additionally, abuse must usually be demonstrated to pierce the corporate veil. However, abuse tends to become an elusive term when courts attempt to apply the word in litigation. In Forsythe, the opinion’s analysis provides that a parent corporation’s power to control the subsidiary, by itself, does not impose a duty. However, an abuse of the power, by exerting too much control, could lead to liability for the conduct of its subsidiaries as an alter ego. This alter ego theory is not based upon any clear abuse but upon control exercised by a parent (or individual shareholder).


The court’s opinion also asserted that parent corporations are not held directly liable for their own wrongdoings but for their actions against third-parties through the agency of subsidiaries. Therefore, even in situations where corporations are deemed not to be alter egos of each other, liability is possible under an agency theory. The Illinois Supreme Court has authorized the use of the agency theory to impose liability on the parent for the subsidiary’s acts. The court reasoned that the subsidiary has the power to bind the parent because the subsidiary acted as the parent’s agent in a transaction(s). However, since shareholders or parents always have the potential to control, an agency theory is always a viable option to bypass limited liability protection. The end result is a movement away from the stringent abuse standard utilized in veil piercing cases, where an alter ego must be established, to the more accessible agency theory where just the presence of control is seemingly sufficient to dispense with limited liability.


As is evident by court decisions, not only in Illinois, but also across the country, the threat to eliminate the protection of limited liability is real. Companies conducting business in Illinois need to adjust their operating procedures to avoid the pitfalls associated with emerging theories that undermine limited liability protection. In particular, liability based upon the direct participant theory looks towards holding parent companies, and not their subsidiaries, for redress. At the expense of eliminating the protection of limited liability, the attachment of liability is moving away from being based upon reprehensible, abusive conduct and towards, simply based upon, shareholder control.

The Significance of Share Transfer Restrictions for Closely held Corporations

Derek P. Usman, The Usman Law Firm, P.A.


While public corporations thrive on share trading in a dynamic market, private corporations often seek to restrict transfer of their shares. In particular, entrepreneurial enterprises foster the inclusion of non-management investors. These silent partners of closely-held corporations often require protective measures for their interests. Therefore, a buy-sell agreement may be utilized to define the parameters under which shareholders may transfer shares.


The parameters present in a buy-sell agreement provide obligations and place restrictions on share disposition when a shareholder leaves a business. Share transfer restrictions allow control over a transfer of shares to avoid undesirable business associates and preserve existing interests. Just as importantly, these transfer restrictions must be drafted to allow transfers in a manner to allow shareholders a market for their shares.


A buy-sell agreement is a contract among business owners or between each owner and the company. Once the agreement is executed, it becomes a part of the corporate bylaws, shareholder agreement or partnership agreement. While shareholders’ agreements address broad concepts of corporate structure, buy-sell agreements contain narrow provisions that should be considered upon the occurrence of particular scenarios. For example, forced buyouts allow for a resolution to deadlocks or to remove unwanted shareholders. Similarly, buyout provisions in a buy-sell agreement might also come into effect upon the occurrence of particular events. Such a provision provides for a forced transfer of shares or an option for the other shareholders to purchase the shares.


One such event addressed in a buy-sell agreement is when an owner contemplates retiring or withdrawing from a business. An appropriate provision for this event would require the owner to first offer to sell his shares back to the remaining shareholders (or to the company) before accepting an offer from an outsider. Also, buy-sell provisions are appropriate when an outside party makes an offer for an owner’s shares. That owner must first offer the shares to the company or its other shareholders on the same terms. If the insiders decline to purchase the shares, then the owner may sell to the outsider. Still yet, the death of a shareholder would prompt the company, or other individual shareholders, to purchase the deceased owner’s shares from his estate. Of course, the estate would be required to sell those shares to the company.


Another event that is accounted for when drafting a buy-sell agreement is when a shareholder has a spousal separation. Again, the avoidance of unwanted business associates is accomplished if the shares are subject to forced transfer to the company or the remaining shareholders under these circumstances. Finally, a couple of financial situations that a business may encounter underline the significance of share transfer restrictions. If a business’ ongoing financial needs prompt additional contributions from a shareholder or when a shareholder faces insolvency (bankruptcy), the company might realize that the shareholder in question is not able to contribute further to the company or the shareholder’s shares are subject to seizure from creditors. Thus, it would be wise for share transfer provisions to be present in a buy-sell agreement for these occasions.


Another important consideration is when a closely held corporation elects to be taxed under Subchapter S of the Internal Revenue Code. To preserve S-Corporation status, a buy-sell agreement for a C-Corporation might not be adequate and the agreement must be tailored for a S-Corporation. A S-Corporation election would be terminated if a shareholder transfers shares to a corporation, certain trusts or a partnership.


Another caveat with S-Corporation agreements is the prevention of any breach of the agreement. While share transfer restrictions will limit how or to whom a shareholder’s interest may be transferred, other provisions might be desirable. These additional provisions would assert that attempted transfers in violation of the agreement are void on their face; that the corporation’s or other shareholder’s purchase options are given effect prior to the breach; and that the occurrence of an attempted breach automatically vests title of the shares in the corporation. Additionally, practitioners may also utilize liquidated damage provisions to help deter the occurrence of a breach.


The presence of share transfer restrictions should also provide a mechanism for establishing a fair price for the shares. There are as many methods of setting the purchase price of shares, as there are members of the Illinois Bar. The facts and circumstances of the business operations should dictate the method employed in setting a fair price. The important thing is to have a pricing method in place before the need arises.


For reference, please note the following relevant Illinois statutes that provide validity to share transfer restrictions contained in buy-sell agreements. In fact, Illinois law imposes share transfers restrictions on an entity that incorporates in the form of a Close Corporation. 805 ILCS 5/1.80(s) states: “Close corporation” means a corporation organized under or electing to be subject to Article 2A of this Act, the articles of incorporation of which contain the provisions required by Section 2.10, and either the corporation’s articles of incorporation or an agreement entered into by all of its shareholders provide that all of the issued shares of each class shall be subject to one or more of the restrictions on transfer set forth in Section 6.55 of this Act.”


As a point of interest, in Edmonton Country Club v. Case [1975] 1 S.C.R. 534 it was held that even with a presumption that shares are freely transferable, a transfer of shares can be restricted. So long as there is no absolute restriction on transfer, share transfer restrictions are generally valid.


Without an agreement restricting share transfers, corporate shares would be freely transferable and prevent the remaining shareholders from maintaining a desirable ownership structure. The provisions drafted in buy-sell agreements allow shareholders to control ownership and create a market for shares that are otherwise likely to be illiquid. Consequently, buy-sell agreements allow for a smooth transition after the occurrence of the aforementioned situations.


Derek P. Usman, The Usman Law Firm, P.A.


Shareholders of a corporation taxed under Subchapter S of the Internal Revenue Code may elect a “pass-through” taxation system. Subsequently, a corporation’s profits pass through directly to its shareholders on a pro rata basis and are reported on the shareholder’s individual tax returns.


The basis of S-Corporation stock is increased by the shareholder’s distributive share of corporate income and gains. The basis is increased to reflect the fact that the shareholder is taxed on his share of the corporation’s undistributed income. The corporate income, whether or not distributed, is taxed to the shareholders. Conversely, the basis is decreased if this previously taxed income is distributed to the shareholder.


Also, the basis is decreased (but not below zero) by the shareholder’s distributive share of corporate deductions and losses. Even though the Internal Revenue Code allows a shareholder to deduct his pro rata share of the corporation’s annual losses, a shareholder must have sufficient basis to utilize the entire deduction. A shareholder may not deduct an amount larger than his basis for the stock and any corporate indebtedness owned by him. Otherwise, any unused losses may be carried forward indefinitely. If there are excess corporate losses and deductions from prior years, the shareholder must reduce the basis of the stock to reflect the fact that these amounts have been passed through for use on his individual tax return. Regulations under Section 1367 provide for adjustments to stock basis and debt basis.


Suppose S-Corporation Acme incurs an operating loss of $100,000 in 2006. Also, Craig is the sole shareholder of Acme and Craig’s basis in his stock is $20,000. Furthermore, if Craig is a creditor of Acme for the amount of $50,000 then Craig may only deduct $70,000 in 2006. Nevertheless, if during 2006 it appears that Craig’s basis will be insufficient to absorb Acme’s operating loss then Craig needs to plan accordingly by increasing his basis prior to year-end. Craig has a few options to increase his basis and deduct the loss. Craig could purchase additional shares, contribute to the capital or paid-in surplus of the corporation, or loan money to the corporation.


Under Section 1366, a shareholder’s basis increases when a shareholder loans money to the corporation. Furthermore, it is the shareholder’s burden to establish his basis under Section 1366. Unlike a partnership, any borrowing conducted by the corporation does not allow a shareholder to increase his basis in stock. The courts have determined that Congress intended to limit a shareholder’s loss deduction by the amount the shareholder invested in the corporation.


If Craig decides to loan money to Acme, his investment must meet certain criteria. Thankfully, the courts have had ample opportunities to establish clear guidelines for S-Corporation shareholders like Craig. Practitioners need to look no further than the recent tax court case, Miller v. Commissioner of Internal Revenue, T.C. Memo 2006-125, for guidance when advising clients. For an injection of resources by Craig to be deemed an investment, the investment must be an “actual economic outlay” of money. Furthermore, the actual economic outlay must leave the Craig “poorer in a material sense”. The “poorer in a material sense” standard is simply a restatement for the analysis of an ordinary deduction. In other words, as a shareholder, Craig’s financial position should not remain the same after the transaction. If a shareholder is only secondarily or contingently liable then shareholder is unable to increase the basis. For example, a shareholder’s guarantee of a bank loan to the corporation or a pledge of property as security will be insufficient to increase the shareholder’s basis because the shareholder will only be deemed to be secondarily or contingently liable. Even though both a guarantor and lender assume a risk of default, when distinguishing between a guarantor and a lender, the analysis focuses on the lender supplying funds for the borrower. On the other hand, by assuming a risk of default the guarantor only enables the funds to be supplied to the borrower.


In Oren v. Commissioner, T. C. Memo 2002-172, the taxpayer unsuccessfully argued that a direct loan, in itself, is sufficient to increase basis. The court rejected the idea that an economic outlay is required only when there is a shareholder guaranty. The economic outlay doctrine is even applicable to transactions masked as direct loans. If the source of funding is originally from a related party, then a sufficient economic outlay by the shareholder to create basis has not occurred. The courts continue to reason that there is no economic outlay because repayment of the funds is uncertain. The shareholder must be directly liable or must loan his own money to the S-Corporation. In fact, the presence of a third-party lender does not negate basis-generating indebtedness. On the contrary, the third party lender becomes a significant factor in the determination of the loan as a valid economic outlay. An arm’s length transaction from an unrelated party provides certainty that the lender will enforce repayment form the shareholder. The funds loaned to a S-Corporation from a “back to back” loan borrowed by the shareholder results in an economic outlay.


Another scenario where Craig could create genuine indebtedness is the when there is a note substitution. If Craig becomes an obligor by substituting his own note for the note of his S corporation (whether or not he was initially a guarantor), there is an economic outlay. In a “note substitution” scenario, the S-Corporation’s is no longer liable to the third-party lender for the note after the shareholder assumes the debt. Nevertheless, the S-Corporation’s indebtedness to the shareholder is deemed a constructive furnishing of funds by the shareholder and thus, an economic outlay.


The presence of appropriate documentation such as notes creating enforceable legal obligations and certified financial statements reflecting a debtor-creditor relationship between the S-Corporation and the shareholder will give substance to the arrangement. Craig should borrow directly from the lender and then loan the funds to the S-Corporation. Furthermore, the lender should record the loan as a loan to Craig. Subsequently, the S-Corporation should record the funds as a loan from Craig, the shareholder. The courts, in particular the Court of Appeals for the Seventh Circuit, apply substance-over-form principles when analyzing a transaction to determine whether an economic outlay took place.


Still yet, even if there is an “actual economic outlay” that increases basis, the funds must be “at risk” within the meaning of Section 465 before a subsequent deduction is deemed proper.   As a starting point, section 465(b)(1) states that generally a taxpayer is at risk in an activity to the extent of money contributed or amounts borrowed for use in the activity. Then, 465(b)(2) designates a taxpayer as at risk for the borrowed amounts if there is personal liability for repayment of the loans or if property unrelated to the business has been pledged as security for loan repayment.


However, if there is a loss limiting arrangement, evidenced by non-recourse financing, guarantees or stop loss agreements, a taxpayer will not be considered to be at risk. While the loan must be fully recourse and the obligation to repay must be absolute, the existence of an indemnification clause is often construed as stop loss agreement. Furthermore, the presence of a guarantor will require an inquiry into the extent to which the shareholder is, in any way, protected against loss. Specifically, the Service has specifically stated that, “If the investor is liable for the loan only upon occurrence of a specific event, the taxpayer is effectively protected against the loss if the likelihood of the event is slim”.


Still yet, even though a guarantor is able to recover from the primary obligor any amounts that the guarantor is required to pay to satisfy the indebtedness, a waiver by the guarantor of his rights will not necessarily preclude the shareholder from being “at risk”. Agreements and arrangements must be reviewed to detect events that trigger or relieve taxpayers of personal liability. The question is always whether the taxpayer who assumes personal liability is ever required to satisfy the liability, or whether he or she is protected in any way from being required to do so out of his or her own funds. Even though a guarantor is able to recover from the primary obligor any amounts that the guarantor is required to pay to satisfy the indebtedness, a waiver by the guarantor of his rights will not necessarily preclude the shareholder from being “at risk”.


After examining all the facts and circumstances, there must be a realistic possibility that the money invested in the business might actually be lost before the amount will considered at risk. The Court of Appeals for the Seventh Circuit has cited the “realistic possibility of loss” standard with approval but has not expressly adopted it.


Furthermore, if there are other shareholders, Craig would not be able to increase his basis by borrowing money from them to lend the money to the S-Corporation. Any funds borrowed from fellow shareholders are not considered at-risk under Section 465.


To sum up, to properly structure Craig’s loan to his S-Corporation, the transaction must first constitute an economic outlay. The substance of the transaction must leave Craig “poorer in a material sense” to be an economic outlay. Secondly, the loan proceeds must be “at risk” where there is a realistic possibility of loss by the shareholder.