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Identifying a personal service corporation.

If a regular or C corporation is categorized as a personal service corporation, it faces two adverse tax consequences. Under Internal Revenue Code section 11, it is required to pay tax at a flat 34% rate without benefit of the lower graduated brackets, and under section 441 it is required to report on a calendar-year basis rather than at fiscal yearend.

In a recent private ruling, the IRS clarified that an entity may be subject to one adverse definition but not the other (TAM 9324001). Surprisingly, a personal service corporation is defined differently in each case. Both definitions apply to eight categories of services: health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting. However, the 34% flat rate applies to corporations that have substantially all of their services in those professions and substantially all of the stock held by employees performing those services.

Conversely, the calendar-year requirement applies when more than 10% of the stock is held by employee--owners and more than 20% of corporate compensation is attributable to the performance of personal services by employee-owners.

The recent IRS ruling points out there is no correlation between the definitions.

Observation: Advisers to regular corporations that operate in the eight personal service professions should review their compensation structures and stock ownership to verify the corporate status under the two sets of definitions.

Unfortunately, the inconsistencies in the definitions require a rigorous examination to determine if a corporation is subject to either detrimental rule. For example, for the calendar-year requirement at least 20% of compensation costs must be attributable to services of employee-owners, whereas the 34%flat rate is imposed if at least 95% of employee time is spent in the stated professions, with no requirement that the owners perform a certain level of services.
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Article Details
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Sep 1, 1993
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