What Is a Personal Service Corporation?

What Is a Personal Service Corporation?

Let me explain what a personal service corporation is—it's a corporation you set up to provide personal services to individuals or groups, and it's recognized as a taxing entity under IRS regulations. These services cover a broad range of professional activities as outlined by the IRS.

Key Takeaways

You should know that personal service corporations are built to deliver services in areas such as accounting, engineering, and consulting. They get taxed at the same 21% rate as C corporations, but they can access extra corporate tax deductions. While they provide tax advantages and limited liability, you have to strictly follow IRS rules to maintain compliance.

How a Personal Service Corporation Works

The services in a personal service corporation can include activities in fields like accounting, engineering, architecture, consulting, actuarial science, law, performing arts, and health, including veterinary services. Note that financial services don't qualify, which is why many financial advisers opt for S corporations instead.

For a C corporation to qualify as a personal service corporation under IRS rules, the employee-owners need to perform at least 20% of the personal services themselves. The IRS calculates this based on the time spent working for the corporation relative to the total service hours. For instance, if the corporation logs 5,000 service hours in a year, employee-owners must contribute at least 1,000 of those hours collectively.

Additionally, these employee-owners must hold more than 10% of the outstanding stock on the last day of the initial one-year testing period. This ensures that those providing the services have a real stake in the business. There's also an income test: employees must dedicate at least 95% of their work time to qualified services.

Understanding Personal Service Corporation Taxes

Personal service corporations calculate taxes by applying a 21% rate to taxable income. Many high-earning professionals choose this structure for its tax benefits, such as leaving earnings in the corporation to be taxed at the lower corporate rate instead of higher individual marginal rates. You can also benefit from tax-free fringe benefits, limited liability, and favorable business deductions.

However, you must follow specific tax rules, like using a calendar-based fiscal year and complying with passive activity regulations. Don't mix this up with professional corporations, which are state-law entities for certain professionals.

Important Considerations

It's essential for you to balance the tax benefits against the administrative and compliance demands of a personal service corporation. The flat 21% rate and deductions might appeal, but factor in the complexity and costs of setup and ongoing compliance.

Personal Service Corporation Test

According to the IRS, someone qualifies as an employee-owner if they are an employee or perform services for the corporation during the testing period—usually the prior tax year—and own any stock during that time, even if they're independent contractors elsewhere.

If you're an owner-employee in creative arts or photography, current expenses for your creative work are deductible for the corporation, but you or your family must own all or nearly all the stock. This doesn't apply to other personal service corporations.

What Are the Benefits of a Personal Service Corporation?

Operating as a personal service corporation can bring tax savings, liability protection for employee-owners, and the chance to use corporate tax deductions for business expenses, employee benefits, and capital expenditures.

What Are the Drawbacks of a Personal Service Corporation?

These corporations can be expensive and complicated to establish, and they're less flexible than other corporate types. If you fail to meet IRS guidelines, you risk audits and hefty tax penalties.

What’s the Difference Between a Personal Service Corporation and an S Corporation?

Personal service corporations and S corporations vary in taxation methods, limits on shareholders' number and type, liability protections, and the services they provide.

The Bottom Line

Personal service corporations provide a specialized structure for professionals in fields like accounting and consulting, blending a flat corporate tax rate with deductions and limited liability. That said, they're not suitable for everyone—you'll need to adhere strictly to IRS rules, and the setup can be complex and costly. Not every business will gain from the 21% rate.