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The Tax Danger of Personal Service Corporations

What is a Personal Service Corporation (PSC) and why is there a potential tax issue for PSCs?  Many S Corporations and LLCs may be considered by the IRS to be a PSC.  This could result in substantial additional business tax burdens.

The IRS has again begun to examine corporations to determine if they are Personal Service Corporations (PSC). There are significant drawbacks to the PSC classification, including no graduated corporate tax rate. PSCs are subject to a flat tax rate of 21% regardless of their income.

A corporation is a personal service corporation if it meets all of the following requirements:

  1. Its principal activity is performing personal services. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.
  2. Its employee-owners substantially perform the services in (1). This requirement is met if more than 20% of the corporation’s compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.
  3. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period.

A person is an employee-owner of a PSC if both of the following apply:

  1. They are an employee of the corporation or perform personal services for, or on behalf of, the corporation (even if they are an independent contractor for other purposes) on any day of the testing period
  2. They own stock in the corporation at any time during the testing period

Please consider all tax ramifications when creating a business or forming an entity. If you have concerns about your corporation, or if you would like to speak to a San Diego tax attorney about legal options for your situation, we invite you to contact Allen Barron or call us today for a free consultation at 866-631-3470.