What is a Personal Service Corporation?
How do you qualify as a personal service corporation?
What are the essential elements you should know!
In this article, we will break down the notion of Personal Service Corporation so you know all there is to know about it!
Keep reading as we have gathered exactly the information that you need!
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What Is A Personal Service Corporation
A personal service corporation (or PSC) is a corporation that provides personal services.
Personal services can include services in various activities such as accounting, law, consulting or other, as it is defined by the IRS.
For the PSC to be qualified as personal service corporations, they must meet the following IRS requirements during the test period:
- The main activity of the corporation is to provide personal services
- The employee-owner performs more than 20% of the personal services for the corporation
- The employee-owner owns more than 10% of the faire market value of the corporation’s outstanding stock
Just like any other corporation, personal service corporations are legal entities formed by an individual who intends to provide personal services.
Personal Service Corporation Definition
Under the United States tax laws, a corporation can be considered a personal service corporation if it meets the following conditions:
- It provides personal services
- The owners (acting as employees or independent consultants) perform at least 20% of the personal services for the corporation
- The owner-employee owns at least 10% of the company’s stock
What Qualifies As Personal Services
According to the IRS, “personal service” includes any of the following fields:
Accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts
For a company to be a qualified personal service corporation, it must meet the requirements established by the IRS.
Section 448(d)(2)(A) of the Internal Revenue Code lists the areas that qualify as personal services as:
health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting
What Is The Personal Service Corporation Test
For a corporation to be considered a “personal service corporation” by the IRS, it must pass the PSC Test.
A company that meets the following requirements during the “testing period” will be considered a personal service corporation by the IRS:
- The company’s principal activity is to provide personal services
- The company’s main activities are performed by its employee-owners where 20% or more of the corporations personal activity compensation costs are allocated to employee-owners
- On the last day of the test period, the employee-owners own more than 10% of the company’s outstanding stock
The “test period” for a tax period is generally considered to be the prior tax year.
If a company was newly formed, the test period will start on the first day of its tax year and will end on the earlier of the last day of its tax year or the last day of the calendar year in which its tax year began.
Personal Service Corporation Tax
Many professionals earning significant professional revenues choose to form a C Corporation qualified as a personal service corporation from a tax point of view.
According to the IRS Publication 542 revised in January 2019, qualified personal service corporations are taxed at a rate of 21%.
Overall, operating a personal service business under a C Corp provides many advantages, such as:
- Company earnings are subject to a lower tax rate than personal earnings
- Possible tax-free fringe benefits
- Limited liability protection
- Business expense deductions
It’s important to note that the objective for operating a “personal service” corporation is not to evade income tax or avoid paying taxes.
In fact, 26 U.S. Code § 269A states that if the principal purpose of forming or availing of a personal service corporation is the avoidance or evasion of Federal income tax, then the authorities may allocate all income between the PSC and its employee-owners.
Qualified Personal Service Corporation
To ensure that personal service corporations are not organized by professionals and high earning individuals to lower their taxes significantly, the IRS applies additional tax rules to qualified personal service corporations (QPSC) intended to reduce some of their tax advantages.
In essence, here are some of the limitations imposed on QPSCs:
- It will not be able to use the graduated income tax rates of C Corporations and is taxed at a flat rate of 35%
- It can only carry forward net operating losses (not backward)
- It has to choose its fiscal year based on the tax rules
The IRS applies the following test to determine if a company is a “qualified personal service corporation”:
- Substantially all of the corporation’s activities involve the performance of a service in the field of health, law, engineering, architecture, accounting, actuarial science, performance arts, or consulting
- At least 95% of the corporation’s stock by value is owned directly or indirectly by the employees performing services, retired employees, estate of an employee, any person who acquired stock because of the death of an employee
A QPSC must use a calendar fiscal year if it also satisfies the compensation test where more than 20% of the compensation paid by the company is to the employee-owners.
Personal Service Corporation vs Professional Corporation
Personal service corporations (PSC) and professional corporations (PC) may sound the same but are different.
A personal service corporation is a taxing entity recognized by the IRS provided that it offers services in one of the personal service areas outlined by law such as accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and performing art.
A PSC must:
- Comply with the tax regulation
- Have a calendar fiscal year
- Adhere to the passive activity regulation
On the other hand, a professional corporation is a corporation organized under state laws in a specific area like only accounting, or law.
A PC has the following characteristics:
- It is taxed like a corporation
- The owners perform work in their capacity as professionals
- The owner’s work must be compensated based on a fair compensation
- Owners pay FICA tax as employees
- It can elect to be taxed as an S Corporation
Personal Service Corporation Examples
Let’s look at an example of PSC to better illustrate the concept.
Imagine a person runs a law firm with a few colleagues.
The lawyers get together and form a C-Corporation where together, the lawyers own all the corporation’s stock.
This newly formed corporation can be qualified as a personal service corporation as:
- The company’s main activity is in the field of law (considered “personal service”)
- The company’s activities are performed by at least 20% of the employee-owners
- More than 10% of the company stock is owned by the employee-owners
Personal Corporation Takeaways
So, what qualifies as a personal service corporation?
What is a personal corporation?
Let’s look at a summary of our findings.
Personal Service Corporation
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