Strictly Business

Business owners and attorneys without a securities background will often engage in transactions that, while on first blush do not involve securities regulation, but actually are a securities transaction, and thus subject to federal and state securities laws.  For instance, real estate developers often finance projects by bringing in outside investors as limited partners.  They are likely to hire a real estate attorney to complete the deal, who will dutifully draft a limited partnership agreement for the transaction.  What neither of them often realize is that a securities transaction is occurring as part of the deal.  The sale of limited partnership interests is usually a securities transaction under federal and state law.  This means that the interests are subject to registration with the SEC and with the state of each investor’s residence[1], unless an exemption can be found. In addition, all statements made in discussions with limited partners are subject to the anti-fraud rules.

The reality is that the definition of “security” a whole lot broader than many people realize.  In fact, it is a lot broader than what many attorneys realize, at least those without a background in securities law.  In this series of posts, I’ll explore when securities laws apply and when they don’t apply to particular transactions.

The Federal Definition of a Security

Each of the main federal statutes (the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Investment Advisers Act of 1940) has a definition of the term “security.”  For the most part, they are all very similar, with only minor differences between them.[2]  So lets start with the definition used in the Securities Act of 1933:

“[U]nless the context otherwise requires… [t]he term ‘‘security’’ means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”[3]

That’s quite a lot to digest, but there are a couple of initial important points.  First, a large number of different types to transactions are securities transactions.  For instance, stock in a closely held business or a note evidencing a loan are both potentially within the definition of a “security.”  Therefore, when incorporating your business, the sale of stock to your fellow co-founders can indeed be a securities transaction.  In addition, the issuance of a promissory note, which happens in most loan transactions, can also be a securities transaction.  So there are a lot of transactions that may be subject to securities laws that you would ordinarily not think of as a securities transaction.  I’ve seen many entrepreneurs think that simply issuing notes, rather than equity, to investors gets them out of complying with securities law.  So does this mean that all loans are securities transactions?  No, it doesn’t, as I will explain below.

The second thing that should be pointed out is what the list contained in the paragraph above does NOT include.  Two examples that immediately come to mind are partnership interests and limited liability company interests.  In fairness, limited liability companies weren’t even invented at the time the Securities Act was passed, but Congress has amended the Securities Act several times since then (in Sarbanes-Oxley, Dodd-Frank, and many other instances as well) and it could have added to the definition.  So does this mean that limited liability company interests are never securities?  Again, the answer is no.

The potential overinclusiveness and underinclusiveness of the federal securities definition is ameliorated by the two phrases which I highlighted above in bold.  The phrase “unless the context otherwise requires” allows a court to, for example, treat a note that is issued clearly as part of an ordinary loan as an ordinary loan and not as a security.  Likewise, courts have interpreted the term “investment contract” very broadly, covering some limited liability company interests, partnership interests, and even the sale of citrus trees (though in this instance, what was being sold was more than just citrus trees).  Therefore, courts have wide latitude to exclude specific instances of the items listed within the “security” definition and to also include items that were not listed as well.

In future posts, I’ll explore what the legal standards are for such exclusion and inclusion in specific scenarios.

Footnotes

[1] And the interests are also potentially subject to registration in the states in which the interests are offered but not sold.  This is, if you send out any promotional material to any residents of a state, it is possible that the securities may need to be registered in that state.

[2] It is unclear if, but unlikely that, any of these minor differences actually makes a difference in the end result of whether a particular transaction involves securities.

[3] The bolding of certain phrases is mine, and is not in the statute.  The explanation of why I highlighted these phrases is explained later in the post.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

One of the benefits to using a limited liability company is the flexibility of being able to choose how the entity is taxed.  After a new LLC is formed, its owners must decide the method by which they would like their business taxed.  By default, an LLC is treated as a pass-through entity, which means that it does not pay federal taxes directly, but its income or loss is allocated to the owners, who then pay taxes on that income.  If the LLC has only one member, it files no tax return and all transactions of the LLC are treated as transactions of the owner for tax purposes.  If the LLC has more than one member, the LLC files a partnership tax return, which reports the LLC’s income and how that income is to be allocated to each owner.  Partnership style taxation is governed by Subchapter K of the Internal Revenue Code.  However, the owner(s) of an LLC, whether the LLC has a single member or multiple members, may choose to have their LLC taxed as a corporation.  In this case, the LLC can be taxed as a so-called “C Corporation,” which is governed under Subchapter C of the Internal Revenue Code, or an “S Corporation,” which is governed by Subchapter S.  This ability of LLC owners to elect the company’s means of taxation is called the “check the box” regulations. Below are summaries of the four methods of taxation of an LLC:

• Disregarded Entity – This is the default rule for any LLC that has only one member.  A single member LLC is treated as though it does not exist for tax purposes and thus the owner is treated as if he were running a sole proprietorship.  All transactions — income and expenses — are included on the owner’s tax return.  Therefore, no separate tax return need be filed for the LLC.
• Subchapter K (aka partnership taxation) – This is the most flexible form of taxation for a multi-member LLC.  All income and losses of the LLC are allocated to the owners, who pay taxes on that income regardless of the amount of cash they received from the company.  A distribution of cash to owners is itself a tax-free event.  The owners of the LLC can be compensated for service to the company (called “guaranteed payments”) in which case the payments are treated as an expense to the partnership and income to the owner.  Subchapter K is quite flexible, and allows the owners to allocate the income between themselves in a variety of ways, sometimes in quite complex formulas (subject to certain limited restrictions in the Internal Revenue Code).  One downside to using a partnership taxation structure is that the income of the partners is generally subject to the self-employment tax.
• Subchapter C – If an LLC elects to be taxed under Subchapter C, it is treated for tax purposes, as if it were a corporation.  The company must file a corporate tax return (regardless of whether there is one member or multiple members) and the LLC itself pays taxes.  Any income that is paid to owners in the form of dividends is also taxable income to the owner (so-called “double taxation”), though the dividends are taxed to the owner at the capital gains rate.  Because of this, many C Corporation owners pay themselves a salary or bonus.  Such income is deductible to the corporation, though the compensation must be “reasonable.”  If the IRS were to deem the salaries paid to an owner as higher than what would be reasonable if the owner were just an ordinary employee, it could reclassify part of the salary as a constructive dividend, subjecting the company to additional taxes and potential penalties.
• Subchapter S – If an LLC elects to be taxed under Subchapter S, it is treated for tax purposes, as if it were a corporation that had elected to be treated as an S Corporation.  In this form, the company will still file a corporate tax return but does not itself pay taxes.  Instead, each owner is allocated a portion of profits or losses based on the percentage interest that they each own.  As in a partnership, the owners must then pay the taxes themselves, regardless of whether any cash has been distributed to them.  Any cash payments to owners (called distributions or dividends) are tax-free.  Active owners are considered employees of the company and can also be paid for their services to the company in the form of a salary or other payments, in which case, the payment will be deductible to the company and will be taxable wage income to the owner.  The benefit of taxing an LLC as an S Corporation is that income that is not paid out as a salary is not subject to self-employment taxes.  However, the IRS can scrutinize the salaries paid to owners and if it deems that the owners have been underpaid, it may reclassify some of the LLC’s income as wages, subjecting the LLC and the owners to additional payroll taxes and potential penalties.  Another disadvantage to using Subchapter S is that the designation is very “fragile.” There are a number of requirements the company must adhere to (such as having only one class of stock and no more than 100 owners).  If the company fails to adhere to these requirements, it will automatically be converted to a C-Corp and face double taxation.  The single class of stock requirement is especially easy to violate inadvertently.  If the LLC gives any owners preferred distributions or distributes distributions in any way except through a straight pro rata method, it could be deemed as having more than one class of stock.  In addition, many of the default provisions in LLC statutes violate the single class of stock requirement, which means that the operating agreement of an LLC taxed under Subchapter S must be carefully written to override the default provisions.

As you can see, there are many factors to consider in choosing how to have an LLC taxed.  Your final choice should be based on your own specific situation.  Therefore, before making any decisions on your form of business, you should speak with your attorney or accountant.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

The American Jobs Act, recently proposed by President Obama, contains a provision closing the co-called “carried interest tax loophole” that benefits many investment fund managers.  Just about all hedge funds, real estate investment partnerships, private equity funds, and venture capital funds in the U.S. are structured as partnerships for tax purposes.  The incentive fee that the manager is paid (usually 20% of all net gains of the partnership) isn’t actually a fee at all.  Rather, when the partnership is formed, it is structured so that the manager (or an affiliate of the manager) owns a 20% interest in all profits generated by the fund.  The benefit to the manager in structuring the incentive fee this way is that all favorable tax treatment that the fund may receive for certain types of income are preserved for the fund manager.  For instance, if the fund earns a gain on the sale of assets that it owned for over one year or if the fund receives qualified dividends from stock, those gains and dividends are taxed at the lower capital gains rate (15%) rather than being treated as ordinary income.  In addition, the manager of the fund does not pay social security or Medicare taxes on the portion of the fund’s profits allocated to the manager, as he would if he were earning it as wages or were otherwise self-employed.  As a result, the fund manager only pays federal income taxes at a rate of 15% on a large portion of his income, and also pays no social security and Medicare taxes on any of the incentive fee earned by him. [1]  If the law were changed, fund manager incentive allocations would be taxed as ordinary income and would also be subject to the self-employment tax (ordinarily 15.3%) to pay both the employee and employer portions of social security and Medicare taxes on such income.

Arguments can go back and forth whether the current tax treatment of investment partnership incentive allocations is (a) a good idea or (b) fair.  Proponents of changing the law say that it is unfair that investment fund managers should pay a lower level of taxation than people in other professions, especially considering that this income is essentially a fee in substance, if not form.  Opponents counter that fund managers take a huge risk in taking much of their fees in this manner, because (a) it is contingent upon the fund making a profit and thus the fee may never materialize and (b) is often (but not always) deferred for a number of years until gains can be realized.  Because of these unique features, they argue that this favorable tax treatment is fair and reasonable.

Regardless of who you may think is right, luckily for fund managers, the legislation is unlikely to pass in the near term.  Given the gridlock in Washington, and the fact that the Republican-controlled House of Representatives would never approve such a provision, fund managers are currently safe.  However, in the long term, the outlook is far more uncertain.   With tax reform on the horizon, fund managers and their representation in Washington will need to be vigilant.  A change like this to the tax code is likely to be popular with voters and since the people who who would be negatively impacted by it are few, it could be an easy concession for Republicans to make in their quest to lower overall tax rates.  As always, stay tuned.

Footnotes

[1] However, the Health Care and Education Reconciliation Act of 2010, among other provisions, enacted a new additional tax, referred to as the “unearned income Medicare contribution,” on net investment income, like the partnership allocations of income and gain from investment funds at a rate of 3.8% which will, if no additional changes in law are enacted, take effect January 1, 2013.  The tax only affects individual taxpayers with a modified gross income over $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for single taxpayers.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Entrepreneur magazine recently posted an article on their blog describing five overlooked legal mistakes that entrepreneurs often make.  It’s a good worthwhile read.  The mistakes mentioned are:

1. Making handshake deals (i.e. not in writing) with clients and vendors.
2. Choosing the wrong business structure (i.e. sole proprietorship, LLC, Corporation).
3. Entering into a partnership without a detailed written agreement.
4. Entering into a 50-50 partnership.
5. Filing a trademark without doing a detailed and extensive search before hand.

I wholeheartedly agree with four out of the five common mistakes.  Perhaps the one I may partially disagree with is mistake number 4: entering into a 50-50 partnership.  50-50 partnerships can certainly present challenges when it comes to governing a company and general decision-making when there is a deadlock between the partners.  However, I think categorically ruling out such an arrangement is a mistake.  Rather, if the partners desire to establish a 50-50 partnership and that relationship is important to them, they should plan ahead and consider adding detailed provisions in their partnership agreement which deals with deadlocks.  In addition, the company buy-sell provisions will have to be carefully considered as well.

Article Referenced: Five Overlooked Legal Mistakes Entrepreneurs Make

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© 2011 Alexander J. Davie – This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

In any business with multiple owners, there is a good chance that at some point, one or more of those owners may no longer be affiliated with the company, whether by choice, death, bankruptcy, or divorce.  It’s important for business owners to plan for this in advance, so that when one of these situations occur, there is a preexisting agreement that sets out an orderly way to handle the situation.  The best way to do this is with a buy-sell agreement.  A buy-sell agreement is a contract between business owners that dictates who can buy a departing owner’s share of the business and establishes a fair price for the owner’s stake. The agreement may also provide procedures to resolve disagreements when a majority of the owners but not all of the owners decide to sell the business.  Here are some reasons why you, as an entrepreneur, don’t want to be in business with other people (even family) without a buy-sell agreement in place:

1. You should be able to choose your partners.  When you made the decision to enter into business with your partners, hopefully you thought extensively about it and did some due diligence on them.  It would be unfortunate to have that diligence and thought go to waste, because if you don’t have a buy-sell agreement in place, your partner’s stake in the business can be transferred to third-parties for a variety of reasons: your partner decides to sell, goes bankrupt and is forced to sell, dies, or gets divorced and his spouse ends up with some or all of his shares.  In this event, you will have new partners that you never counted on having, and this may threaten your business’s ability to continue on its current path.

2. If your partner decides he no longer wants to be involved in the business, you have a way of obtaining his stake in the company so that he can’t continue to influence the business after he is no longer involved.  Buy-sell agreements often provide that if an owner-employee were to become no longer employed by the company, that owner-employee must sell his stake back to the company or the other owners.  Also, since buy-sell agreements provide a mechanism for determining a fair price in the departing partner’s stake, he will be unable to extort an unreasonably high sum on his way out.

3. If you want to leave the business and no longer want to own stock in the company, you have a way of fixing the fair price in your stake.  Again, since a buy-sell agreement sets out a method of determining the fair price of the stake of the departing owner, you can eliminate potential lawsuits and disputes by agreeing in advance what is fair.  This can be of benefit to you if you are the one leaving the company.  Be careful though; if the valuation method is not well thought out, you could end up being unable to get a fair price on your stake in the company on your way out.

4. It could reduce your estate tax burden.  The valuation method contained in a buy-sell agreement is set not only for purposes of an eventual sale, but also for estate tax valuation purposes. Privately owned businesses are difficult to value. An owner’s idea of a business’s worth at his death may be much lower than the IRS’s. However, if you have a buy-sell agreement in place, as long as such agreement is a bona fide arms length transaction, you can use the method contained in that agreement as evidence as to how the business should be valued. But if no process for valuing the business has been put into place, the IRS will be free to determine its own value.

5. It lets the partners set expectations as to the transferability of interests in the company.  Even when a partner does not want to leave the company, he still may want to sell part of his stake in the company to partially “cash out” for any number of reasons.  Putting in place a buy-sell agreement can give the remaining partners a right of first refusal or other protections to give them more control over ownership changes in the company.  In the least, the mere process of writing a buy-sell agreement is beneficial because it gives the partners a chance to discuss and decide these issues at a time when there is often a surplus of good will.

6. It can prevent minority shareholders from vetoing a sale of the business.  If a buy-sell agreement contains a drag along clause, then a majority of owners can force the entire business to be sold.  Without this, it is possible that even a 1% owner could hold up an entire deal, possibly to extort the other owners for a greater portion of the sales proceeds.

7. It can protect minority shareholders from being cheated out of the proceeds of a sale of the business.  Along with point 6 above, if a buy-sell agreement contains a tag along clause, then upon the sale of the business, the minority owners will be entitled to the same price per share as the majority owners.  This prevents majority shareholders from conspiring with a buyer of the business and extracting a control premium from the buyer to the detriment of the minority shareholders.

8. The time when someone leaves a company is not the time to be negotiating the fair value of a business. Often partings are awkward and sometimes downright unpleasant.  Emotions may run high, precluding a careful and thoughtful discussion of how to resolve disagreements. Instead, you should set the mechanism for calculating the value while spirits are high.

9. It can protect your family. One of the most likely reasons why you may need to leave your company or transfer your stake is upon your death or disability. At this point, you will not be capable of negotiating on behalf of your family.  Your family will need and deserves to be paid the fair value for your interest.  If there is no buy-sell agreement in place, the surviving owners may be reluctant to pay a fair amount for your stake and are likely to at least negotiate against your family members.  A buy-sell agreement provides a pre-agreed method of making sure the work you put into your business takes care of the people you care about most.

Buy-sell agreements are a crucial part of business planning for any venture which is owned by multiple parties.  They can be used for corporations, limited liability companies, and partnerships.  Drafting one should not be put off, because if you don’t put one in place at the outset, you are unlikely to do so until issues arise.  You should consult an attorney with experience in business and corporate matters for more information.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

After my recent post regarding exemption from investment adviser registration of venture capital funds and small hedge funds, I had a number of people ask me about the status of real estate funds under the new regime.  Do the managers of real estate investment funds and partnerships need to register as investment advisers either under the pre or post-Dodd-Frank regime?  The answer has always been somewhat ambiguous, but in my view, if the fund is a true real estate fund (i.e. it buys only real estate rather than interests in companies that own real estate), then its manager does not have to register. The Dodd-Frank Act did not change this analysis.

The definition of an “investment adviser” under the Investment Advisers Act is “any person who, for compensation, engages in the business of advising others… as to the value of securities or as to the advisability of investing in, purchasing, or selling securities.”  The key word in that definition is the last one.  If a fund does not invest in securities, then its manager or adviser is not acting as an investment adviser, which means that its activity falls completely outside the scope of the Investment Advisers Act.

So when is real estate a security and when is it not?  The definition of the word “security” is complex, encompassing extensive statutory definitions and a long line of case-law.  If you are interested in the legal reasoning behind what real estate assets are and aren’t securities, Doug Cornelius, a fellow legal blogger, has posted a great discussion of it here, so I won’t reinvent the wheel by repeating it.  However, I will provide some practical guidelines to use in analyzing your own situation.

Here are how I believe each real estate asset type would be classified:

• Direct Real Estate Ownership.  A direct fee simple interest in real estate would not generally be considered a security.  However, a TIC (tenant in common) interest in real estate may or may not be a security depending on the degree of control the fund maintained.  If the fund has control or is active in the management of the real estate, it will likely not be a security, but if the fund is a passive owner, it likely will be considered a security.
• Stock.  Stock in a corporation that owns real estate would always be considered a security. There may be an exception if the corporation is a wholly owned subsidiary of the fund, but it would not be a good idea to test this, since courts have come pretty close to ruling that stock is always a security.
• Partnership and LLC Interests.  A limited partnership interest in a partnership that owns real estate or a non-managing member interest in a limited liability company that owns real estate is likely to be a security.  A general partnership interest in a partnership or a managing member (or a member of a member-managed LLC) generally is not a security.  Fee simple real estate owned by a wholly owned LLC subsidiary of the fund would likewise not be a security.
• Joint Ventures.  With joint ventures, the situation depends on the degree of active participation.  Similar to the discussion above, re: partnerships and LLCs, if the fund is an active participant, generally its interest is not a security, but if the fund is passive, then the interest could be deemed to be a security.
• Commercial Mortgage Loans.  Common sense would say that commercial mortgage loans would not be a security, because if they were, every borrower would also be an issuer of securities.  This is obviously not the case.  However, securities laws provide that any “note” is presumptively a security unless the context would indicate otherwise.  Therefore, a fund that owns a portfolio of commercial mortgages that it purchased from a non-affiliated originator would likely be considered to be holding a securities portfolio.  However, if the fund were to instead make direct commercial mortgage loans to borrowers, then the context would likely dictate that the loan is not a security.

As you can see, determining whether a specific asset is a security can be complex.  In addition, it may often be the case that a fund’s assets may consist mainly of real estate but the fund also owns a smaller amount of its assets in other categories such as limited partnership interests.  The Investment Company Act (a separate statute from the Advisers Act) generally provides that a company will be considered an investment company (i.e. a portfolio of securities), if the securities owned by that company has a value exceeding 40 percent of the value of the company’s total assets.  Arguably, if a fund is not considered to be a securities portfolio, then its manager would also not be considered to be an investment adviser.  This line of reasoning has yet to be tested by the SEC or the courts.

Given the very fact specific nature of these issues, you should consult a qualified attorney in making the decision of whether to register as an investment adviser.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

One of the first decisions a small business owner faces is choosing the right form of entity for his or her company.  The most popular form of business in recent years is the limited liability company (LLC), because it is simple to organize and manage and can be taxed as a partnership (i.e. without the “double taxation” associated with C-Corporations).  However, there are many reasons why you should avoid structuring your new business as an LLC taxed as a partnership and instead use a C-Corp structure.  Here are some of them:

1. Venture capital funds will usually only invest in a C-Corp.  Many VCs are funded by pension funds and the Internal Revenue Code makes it difficult for pension funds to invest (even indirectly) into an entity taxed as a partnership (as LLCs by default are) if that entity carries on an active business. Therefore, if your goal is to eventually attract venture capital or private equity money, using a C-Corp structure is essential.

2. With a C-Corp, you will receive a W-2 instead of a K-1.  If your company is an LLC taxed as a partnership, as an owner of the company, you will not be permitted to also be an employee.  Therefore at the end of the tax year, you will receive a K-1 instead of a W-2.  If you want to finance anything (like a house or a car), banks prefer to see a W-2.  It’s just what they are used to seeing.  But if you use a C-Corp, you will also be permitted to be an employee of your company and can take your compensation as wages, and will thus have proof of your income in the form of a pay stub and a W-2.

3. With a C-Corp, you will be able to get your personal taxes done quickly.  If you are in a partnership, you must wait until you receive a K-1 from your company before you can file your own taxes, and the K-1 can only be completed once your company’s partnership tax return has been completed (which depending on the complexity of your company, may take some time).  In contrast, if you are an employee of your own company, all you will need is your W-2 to do your taxes (and a 1099-DIV if you get any dividends, but see item 7 below on why in most cases you shouldn’t be receiving dividends).  W-2s and 1099-DIVs are based solely on the cash your company pays to you, so they can be completed far in advance of your company’s tax return.

4. With a C-Corp, all your employee benefits are deductible.  Owners of partnerships and S-Corporations are limited in the amount they can deduct for certain benefits like medical, life insurance, education, childcare, and retirement plans.  Owners of C-Corps have no such limitation.

5.  C-Corps have their own progressive tax brackets.  This means that you can split your income between your company and yourself by choosing how much you pay yourself in compensation. Since the income will be split between two entities, each will be better positioned to avoid the higher tax brackets.

6. You don’t have to forego the simplified management structure of an LLC.  If you really want a simple LLC-type management structure, form an LLC, then file Form 8832 with the IRS and elect to have your LLC taxed as a C-Corp.  You will get the best of both worlds.

7. Double Taxation isn’t really the big problem that it seems.  For C-Corps, if you are an active owner in your business, then you are both an owner and an employee.  The compensation you receive can be treated as wages rather than a dividend, in which case, it is only taxed once.  Done right, you can avoid double taxation completely.  Please note however, this strategy would not work with a capital-intensive company that invests in acquiring significant assets like real estate or machinery.  If a large part of your company’s income is derived from its assets, then your company’s income may exceed what you would reasonably expect to make as an employee.  If this happens, the IRS may try to re-characterize part of your wage income as a dividend.  On the other hand, the C-Corp structure is great for companies whose entire income is derived from the efforts of their employees (like consulting firms and law firms) because it would be difficult for the IRS to challenge paying out all of the income to employees since they are responsible for generating it.

As always, your final choice in entity selection should be based on your own specific situation.  Therefore, before making any final decisions on your form of business, you should speak with your attorney or accountant.

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.