A personal service corporation is a special corporate model designed to provide personal services to individual or group clients. Established under specific IRS regulations, these corporations engage in various professional activities as dictated by the IRS.
Key Insights
- Specialized Services: Personal service corporations provide services in fields such as accounting, engineering, architecture, consulting, actuarial science, law, performing arts, and health. Financial services like those offered by financial advisers are generally excluded.
- Tax Rate: These corporations are taxed at a flat rate of 21%, similar to C corporations, offering potential benefits in corporate tax deductions.
- Compliance Needs: Strict adherence to IRS rules is crucial for maintaining tax benefits and limited liability protection.
How Personal Service Corporations Operate
Services offered by personal service corporations span multiple professional fields. Some key points include:
- Service Requirements: Employee-owners must perform at least 20% of the personal services provided, measured in service hours. For example, if a corporation’s total yearly service hours equal 5,000, the employee-owners must contribute at least 1,000 hours.
- Ownership Rules: Employee-owners should hold more than 10% of the corporation’s outstanding stock by the end of the first year testing period, emphasizing their active role in operations and investment.
- Working Time: At least 95% of an employee’s work time should be dedicated to qualified services.
Taxing a Personal Service Corporation
Personal service corporations are taxed at a flat rate of 21%. This structure allows professional groups to benefit from retaining profits within the corporation, taxed at a lower rate compared to individual marginal tax rates. Additional perks include access to tax-free fringe benefits and preferences in business deductions. However, corporations must adhere to intricate fiscal rules, such as using a calendar-based fiscal year.
Compliance Test for Personal Service Corporations
The IRS sets forth specific conditions to qualify as an employee-owner within a personal service corporation:
- Becoming involved in corporate services during the testing period as an employee or on behalf of the corporation, even if classified as an independent contractor otherwise.
- Holding corporate stock anytime within the testing period.
Special Rules for Creative and Fine Arts
For professionals in creative fields like the arts or photography, expenses incurred for creative work are deductible, provided either the owner/employee or their family members own nearly all corporation stock.
Advantages of a Personal Service Corporation
Operating as a personal service corporation offers various benefits:
- Tax Savings: Benefit from a flat 21% corporate tax rate and eligibility for business deductions.
- Limited Liability: Employee-owners gain the advantage of limited liability protection.
- Corporate Deductions: Access to deductions for business expenses, employee benefits, and capital expenditures.
Challenges of a Personal Service Corporation
However, there are certain drawbacks:
- Setup Complexity: Setting up a personal service corporation can be costly and complex.
- Regulatory Compliance: Maintaining strict compliance with IRS rules is essential to avoid penalties and potential audits.
Comparison to S Corporations
Key differences between personal service and S corporations include differing tax structures, shareholder restrictions, liability protections, and services offered, each with unique operational requirements.
The Bottom Line
Choosing a personal service corporation brings the advantages of a flat corporate tax rate, potential deductions, and limited liability protection beneficial for many professionals in various fields. Nonetheless, strict compliance and thoughtful consideration of tax benefits versus the complexity of administrative upkeep are imperative to making an informed decision.
Related Terms: C Corporation, S Corporation, marginal tax rates, passive activity, business deductions
References
- Internal Revenue Service. “Publication 542, Corporations.”
- Internal Revenue Service. “Publication 542, Corporations.”
- Internal Revenue Service. “Publication 542, Corporations”.
