Personal Service Corporation - Explained
What is a Personal Service Corporation?
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Table of ContentsWhat is a Personal Service Corporation?How Does a Personal Service Corporation Work?Personal Service Corporation ConditionsTax ObligationTest ConsiderationAdhere to the Calendar YearBenefits of Personal Service CorporationPersonal Service Corporation Limitation
What is a Personal Service Corporation?
A personal service corporation refers to a corporation purposely created by professionals to provide personal services and take advantages of a lower rate of taxation on profits. The owners of the corporation provide the services. The entity is taxed as a C corporation. The owners to attribute their earnings to the corporate entity, which is generally taxed at a lower rate than the individual service provider's tax rate. As such, the percentage of profit left within the corporation avoid many of the taxes the individual would pay if she were to receive the income as direct compensation. According to IRS, the C corporation can only qualify to be a personal service corporation if its members (the professionals) own over 10% of the stock and should provide not less than 20% of personal services for the corporation.
How Does a Personal Service Corporation Work?
A personal service corporation is a specific IRS tax designation for a corporate business entity. It is a mandatory requirement for personal service corporations employees to spend not less than 95% of their time working on qualified services in the following fields:
- Actuarial science
- Performing arts
Personal Service Corporation Conditions
There are certain conditions that apply to personal service corporation, and they are as follows:
The personal service corporations have some tax obligations that they must meet. For instance, they must pay a corporate tax rate of 21% (as of 2018) on all of their revenues. It is also worth noting that the corporations are only allowed to retain a sum of money not exceeding $150,000 in their yearly earnings. The money should be utilized to boost the value of the corporation on things such as building renovations, real estate acquisition, and expansion costs, among other improvements.
For personal service corporations to be put into consideration as a partnership for the purpose of taxation, they must go through ownership and function tests successfully. To be eligible, they must achieve 95% of the service that professionals provide in a field like engineering, law, medical, accounting, among others. When it comes to ownership tests, the outstanding stock of the corporation must be under the ownership of the employees either directly or indirectly. Note that when retired employees own stock or the heirs of the employees, it means that the employee owns the stock indirectly through them.
Adhere to the Calendar Year
Personal service corporations should adhere to the calendar year as well as the tax year as they are not allowed to choose their own fiscal year. The other alternative is for them to file Form 1128. The form is for Application to adopt, change, or retain a tax year. They can also fill Form 8716. The form is for election to have a tax year instead of the existing one. However, for corporations to fill either of the forms, the Internal Revenue Service (IRS) must first approve the request. If a given corporation decides to file form 8716, then there is a possibility that the IRS will put a limit to a given amount of deductions payable to employee-owners.
Benefits of Personal Service Corporation
There are a number of benefits that members of a personal service corporation enjoy. They include the following:
- Personal service corporations enjoy a tax advantage. For instance, salaries and bonuses are tax-deductible, including fringe benefits like employees health insurance coverage. Business expenses for their annual revenue are also tax-deductible. Business expenses include things like start-up, operation, equipment purchase, and marketing costs. All these deductions reduce their tax liability.
- Another benefit is that the personal service corporation can continue its operation even if one or more of its members die or withdraw from the corporation.
- Also, the owners enjoy limited liability protection. What this means is that an owner is held responsible for his or her own negligence that may lead to civil or criminal charges. In other words, as an owner, you cannot be held liable for any negligence committed by another owner.
- Finally, a personal service corporation usually has a retirement plan for its members with a higher contribution compared to other corporations that operate as a different business structure.
Personal Service Corporation Limitation
Double taxation is the major disadvantage of a personal service corporation. If the corporation has shareholders, it will issue them tax profits as dividends. During the filing of individual tax returns, it is a must for the shareholders to report these dividends, which undergo taxation again as the IRS considers it to be an income. Key Takeaways
- A personal service commission refers to a corporation purposely created by professionals to give them personal services
- The personal service corporation can only qualify to be a personal service corporation if its members own over 10% of the stock and personally provide not less than 20% of personal service to the corporation
- Personal service corporations employees must spend not less than 95% of their time working on qualified services