Key Takeaways
- PSC requires 95% employee-owner stock ownership.
- Flat 21% corporate tax rate, no deductions.
- Qualifies for personal services like law and medicine.
What is Personal Service Corporation?
A Personal Service Corporation (PSC) is a specific type of C corporation primarily engaged in performing certain personal services such as health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. To qualify, at least 95% of its stock must be owned by employee-owners who provide these services, with strict IRS rules under Section 448(d) governing its classification and taxation.
This designation aims to prevent high personal income from being converted into lower corporate taxes, affecting the ability to pay taxation for professionals operating through a corporation.
Key Characteristics
Personal Service Corporations have distinct traits that set them apart from other entities:
- Ownership: At least 95% of the stock must be owned by employee-owners performing the services.
- Service Scope: Activities are limited to specific personal services like law, medicine, or accounting.
- Taxation: Taxed at a flat corporate rate without the benefit of graduated rates or small business deductions.
- Compensation: Often pay out most income as wages to employee-owners to reduce potential double taxation.
- IRS Oversight: Subject to strict IRS scrutiny to prevent abuse of compensation and tax rules.
How It Works
A PSC operates under C corporation tax rules but with unique limitations. The corporation pays a flat tax on all taxable income, currently at 21%, similar to other C corporations, but it cannot take advantage of graduated corporate tax rates or small business deductions. This structure impacts the take-home pay of employee-owners due to possible double taxation when profits are distributed as dividends.
To mitigate tax burdens, many PSCs allocate most earnings as salaries to employee-owners, which are deductible expenses for the corporation but taxable to individuals as earned earnings. However, the IRS closely monitors compensation levels to avoid excessive or unreasonable wage payments that could shift profits improperly.
Examples and Use Cases
PSC status commonly applies to professional service firms with concentrated employee ownership and specialized expertise:
- Law Firms: A law firm where attorneys own the majority of stock and perform legal services qualifies as a PSC.
- Accounting Practices: An accounting firm with employee-accountants holding 95% or more stock and conducting audits or consulting meets PSC criteria.
- Healthcare Providers: Medical groups that meet ownership and service tests may be classified as PSCs and could consider investing in best healthcare stocks to diversify income.
- Performing Arts and Consulting: Organizations in these sectors with qualifying ownership structures also fall under PSC regulations.
Important Considerations
When operating as a Personal Service Corporation, be aware of the higher effective tax rates due to the flat corporate tax and potential double taxation on distributions. Planning for compensation and profit allocation is critical to optimize your overall tax position while complying with IRS guidelines.
Additionally, PSCs differ from entities that benefit from graduated corporate rates or pass-through taxation, so evaluating your business structure in light of your growth strategies or dividend preferences could impact long-term financial outcomes.
Final Words
Personal Service Corporations face a flat corporate tax rate and limited deductions, making compensation strategy critical to managing tax liability. Review your payroll and dividend plans with a tax professional to optimize your overall tax position.
Frequently Asked Questions
A Personal Service Corporation is a C corporation primarily engaged in providing specific personal services like health, law, engineering, or consulting. At least 95% of its stock must be owned by employee-owners who perform those services, along with retired employees or their heirs for up to two years after death.
Businesses in fields such as health care, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting commonly qualify as PSCs. They must meet strict employee-ownership and service performance criteria set by the IRS.
Personal Service Corporations are taxed at a flat 21% corporate rate without the benefit of graduated tax rates or small business deductions available to other C corporations. Additionally, distributing profits as dividends can lead to double taxation, including shareholder-level taxes.
At least 95% of the PSC’s stock, by value, must be owned by employee-owners who perform the personal services, retired employees, their estates, or heirs for a limited period. This strict ownership threshold ensures the corporation remains closely held by service providers.
The IRS imposes special rules on PSCs to prevent the conversion of high-taxed personal service income into lower-taxed corporate income. These rules include strict tests on service activities and employee ownership to maintain the corporation’s classification.
While PSCs face double taxation on dividends, many mitigate this by paying most income as deductible wages to employee-owners. However, the IRS closely monitors excessive compensation to prevent abuse of this strategy.
Unlike standard C corporations, PSCs must have at least 95% ownership by employee-owners performing personal services and are taxed at a flat 21% rate without graduated brackets or small business deductions. Standard C corporations have more flexible ownership and tax structures.
