Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f303.sbe

Text File | 1997-01-01 | 21KB | 562 lines

@Q01

           ┌───────────────────────────────────────────────┐
           │         PERSONAL SERVICE CORPORATIONS         │
           │  AND QUALIFIED PERSONAL SERVICE CORPORATIONS  │
           └───────────────────────────────────────────────┘

Tax laws can be confusing.  A good example is the fact the
tax code uses 3 very similar definitions of "PERSONAL SERVICE
CORPORATIONS" and "QUALIFIED PERSONAL SERVICE CORPORATIONS"
for varied purposes.  Even tax pros find the tiny differences
between the 3 definitions maddeningly complex and obscure.

Definition #1 of "personal service corporations" has to do with
whether a corporation is subject to limits on passive activity
losses; #2 is a virtually identical definition of PSC's that
decides whether a corporation will be allowed to use certain
fiscal years for tax purposes; #3 is a slightly different
definition ("qualified personal service corporations"), that
determines whether a corporation is subject to a flat 35% tax
rate and if it can use cash method accounting in certain cases.

QUESTION:  Which definition do you want to test your company for?
           1- "Personal Service Corporation" -- Subject to passive
               loss rules and unable to freely choose fiscal year.
           2- "Qualified P.S.C." -- Subject to flat 35% tax rate.
@MC\02
01\Q02
02\Q11

@Q02

LIMITATIONS ON CERTAIN "PERSONAL SERVICE CORPORATIONS."  Some
C corporations that fall under the definition of "personal
service corporation" are fully subject to the passive activity
loss restrictions that apply to all taxable entities other than
C corporations.  The law has a virtually identical definition
of "personal service corporation" that is used to determine
whether a corporation is restricted in its choice of fiscal
year.  Being determined to be a personal service corporation
("PSC") under EITHER definition is almost always bad news.

The first type of PSC is fully subject to the limits on loss
deductions from passive activities (like real estate rentals);
they can't offset passive activity losses against either
"portfolio" or "net active" income.  The second type of PSC
is very limited in its choice of fiscal year, usually limited
to using the calendar year. These two definitions are so nearly
identical that we have lumped them together here for analysis.

  QUESTION:  Is your firm a C corporation?
@YN
01\Q04
02\Q03

@Q03

CONCLUSION:

Your company is not a "personal service corporation" ("PSC")
subject to the passive activity loss rules, since your form
of business is not a C corporation.

But don't break out the champagne yet.

This does not mean you are free from the passive loss
limitations.  To the contrary, ANY other kind of business
organization other than a C corporation (such as a
partnership, LLC, sole proprietorship or an S corporation)
is AUTOMATICALLY subject to the passive loss restrictions.

(Rules for business trusts, which may be treated as
corporations, are somewhat more complex and are not
considered here, since few small businesses are set
up as business trusts.)

Not being a C corporation also means that you are severely
limited in your choice of fiscal year, since only certain C
corporations (those which are not PSCs) may freely choose
any fiscal tax year they choose.  PSCs, partnerships, and S
corporations all must generally adopt either a calendar year
(December 31 year-end) or, in the case of partnerships, a
year-end that coincides with that of most of its owners.

It is also frequently possible for some such entities to
select a year that ends in either September, October, or
November, but, if this is done, it will be necessary, in
the case of S corporations or partnerships, to make complex
tax prepayments each year that will undo any tax deferral
benefits that might otherwise result from having a tax year
other than a calendar year.  Similarly, a PSC that elects a
fiscal year may have to give up the right to deduct certain
expenses in order to make sure that it does not enjoy any
tax deferral benefits.

Of course, you can always apply to the IRS to let you choose
a fiscal year for some good business reason other than
deferring taxes, if you have one.

@STOP

@Q04

For a C corporation to be a "personal service corporation,"
the corporation's principal activity must consist of the
performance of personal services.  Personal services would
cover a wide range of activities, including professional
services such as law, medicine, dentistry, accounting,
architectural and engineering services, actuarial sciences,
and the like.  It would also cover areas such as consulting
services, the incorporated professional athlete or entertainer,
and miscellaneous other service businesses, such as an
incorporated salesperson.

  QUESTION:  Does your corporation perform personal services
             as its principal activity?

@YN
01\Q08
02\Q05

@Q05

CONCLUSION:  Your C corporation is not subject to the
limitations on choice of fiscal year.  Thus, if it is a new
corporation, you can choose whichever month of the year as
its year-end that you desire.  You may be able to gain some
significant tax deferral benefits, if, for example, you
choose a January 31 fiscal year, and pay yourself a major
fiscal year-end bonus each year in January.

CONCLUSION:  Your company is also not a "personal service
corporation" for purposes of the passive loss rules, and
thus is not fully subject to the passive activity loss
limitations.  However, your company may be a "closely held
C corporation" that is partially subject to the passive loss
rules, depending on its stock ownership.  (See below)

QUESTION:  Did 5 or fewer individuals (directly or indirectly)
       own more than 50% (in value) of the stock of the
       corporation during the last half of the tax year?
@YN
01\Q06
02\Q07

@Q06

FURTHER CONCLUSION:  While your corporation is not considered
a "personal service corporation," and thus is not fully
subject to the passive loss restrictions, it is considered to
be a "closely held C corporation," and thus is partially
subject to the passive loss rules.  That is, it may offset
passive activity losses against its "net active income" --
but NOT against its "portfolio income."

@STOP

@Q07

FURTHER CONCLUSION:  Your C corporation is not a "personal
service corporation" (within the meaning of the passive
loss rules), and is also not considered a "closely held C
corporation." This means, if the above conclusions are both
correct, that your corporation is not subject to ANY of the
passive loss restrictions.  Thus, losses incurred by your
corporation on passive activity investments should be fully
available to offset against either portfolio income or other
income ("net active income") of the corporation, without
restriction.

@STOP

@Q08

SERVICES "SUBSTANTIALLY PERFORMED" BY SHAREHOLDER-EMPLOYEES:
To be deemed a "personal service corporation," the personal
services performed by the corporation must be "substantially
performed" by employees who own its stock.  To determine if
services to customers, clients, etc. are "substantially"
performed by employee-owners, IRS regulations say that more
than 20% of the corporation's compensation expense attributable
to its service activities must be attributable to services
performed by its employee-owners.  If it is clear that over 20%
of the cost of performing services (of the types described in
the previous question) are attributable to services performed
by owners, answer "Y" ("YES") to the following question.  If
it is clear that LESS than 20% of such compensation costs are
attributable to services rendered by employee-owners, you
should answer "N" ("NO").

QUESTION:  Are services rendered by the corporation
"substantially" performed by shareholder-employees?

@YN
01\Q09
02\Q05

@Q09

STOCK OWNERSHIP REQUIREMENT:  A corporation cannot be
treated as a PSC for tax purposes unless employees own more
than 10% of its stock (by value), directly or indirectly.

  QUESTION:  Do employee-own