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1992-04-30
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@046 CHAP ZZ
┌───────────────────────────────────────────────┐
│ PERSONAL SERVICE CORPORATIONS │
│ AND QUALIFIED PERSONAL SERVICE CORPORATIONS │
└───────────────────────────────────────────────┘
"The words of such an act as the income tax merely dance before
my eyes in a meaningless procession: cross-reference to cross-
reference, exception upon exception--couched in abstract terms
that offer no handle to seize hold of--leave in my mind only a
confused sense of some vitally important, but successfully con-
cealed, purport, which it is my duty to extract, but which is
within my power, if at all, only after the most inordinate ex-
penditure of time. I know that these monsters are the result
of fabulous industry and ingenuity, plugging up this hole and
casting that net against all possible evasion; yet at times I
cannot help recalling a saying of WIlliam James' about certain
pasages of Hegel: that they were no doubt written with a pas-
sion of rationality but that one cannot help wondering whether
to the reader they have any significance save that the words
are strung together with syntactical correctness...."
--Judge Learned Hand, referring to the 1939 Internal Revenue
Code, a statute which was almost childlike in its simplicity
when compared to our current tax law.
A "personal service corporation" under today's tax laws is a regular
corporation that is principally engaged in providing personal services,
where more than 10% of the stock of is owned by its employees. Unlike
other C corporations, such a corporation is fully subject to the
limitations on passive activity losses, in much the same way as an
individual.
A second, and somewhat similar definition of a "personal service
corporation" is provided for purposes of determining whether a C
corporation will be allowed to use a fiscal year end for tax purposes.
A corporation that is considered to be a "personal service corporation"
under this second definition will not be allowed (generally) to elect a
fiscal tax year (unless it already did so by filing Form 8716 before
August 26, 1988). Being categorized as "personal service corporations"
under either of these two definitions will almost always prove to be a
disadvantage for tax purposes, rather than an advantage.
Yet another very similar, but not identical, tax concept is that of
the "qualified personal service corporation." (A corporation may fall
under either none, one, two or all three of these 3 definitions of
"personal service corporations" and "qualified personal service cor-
porations.") A "QUALIFIED personal service corporation" is one that
performs services (which are substantially all of its activities) in
the fields of health, law, engineering, architecture, accounting,
actuarial sciences, performing arts or consulting, where substantially
all of its stock is owned by the employees or retired employees (or by
the estates of such persons).
There is a major disadvantage if your corporation is considered to
be a "qualified personal service corporation" -- It is not permitted to
benefit from the lower graduated tax rates available to other C corpor-
ations. Instead, all of its income is subject to tax at the maximum
federal corporate tax rate, currently 34%. On the other hand, even if
such a corporation has average annual gross receipts of more than $5
million for the past three years, it will be allowed to use the cash
method of accounting (which can be advantageous), rather than being
required to use accrual method accounting for tax purposes. Thus, it
can sometimes be a two-edged sword if your C corporation is categorized
as a "qualified personal service corporation," at least for a large
firm.