Personal Service Corporation: Definition, Key Features, and Taxation

August 24, 2024 4 min read Business Taxation Tax Law Corporation Professional Services Business Law Accounting

Learn all about personal service corporations, including their definition, key features, and how taxation works in various professional fields such as accounting, law, and health services.

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A Personal Service Corporation (PSC) is a type of corporation that is established primarily to provide personal services to individuals or groups in specified fields. These fields typically include accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.

Definition and Key Attributes

A Personal Service Corporation is characterized by several key attributes:

Primary Activity: The corporation’s primary business activity must be the provision of personal services.
Ownership Structure: More than 95% of the corporation’s stock must be owned by employees who provide personal services, or by their estates.
Employee Involvement: Employees who own the corporation must be involved in the delivery of these services.

Relevant Fields

The fields that typically constitute personal services encompass:

Accounting: Services such as auditing, financial planning, and tax preparation.
Actuarial Science: Actuarial valuations, risk assessments, and financial forecasting.
Architecture: Design and planning services related to building and construction.
Consulting: Advisory services across various industries.
Engineering: Design, analysis, and consultation in engineering sectors.
Health Care: Medical, dental, veterinary, and other health-related services.
Law: Legal services including advice, representation, and documentation.
Performing Arts: Artistic services in film, music, theater, and related fields.

Taxation of Personal Service Corporations

Income Tax Rates

Personal Service Corporations are subject to specific income tax treatments. Generally, the most significant consideration is that they are taxed at a flat rate. For instance, in the United States:

Flat Tax Rate: PSCs are typically taxed at a flat rate of 21%, equivalent to the corporate tax rate.

Deductibility and Expenses

PSCs can deduct business expenses similarly to other corporations, but there are nuances:

Salary Deductions: Payments to shareholder-employees must be reasonable and reflect market rates.
Benefits: Fringe benefits provided to employee-owners can have different tax treatments.

Accumulated Earnings Tax

PSCs must also be cautious with accumulated earnings to avoid additional taxes:

Accumulated Earnings Tax: Additional tax may apply if earnings are retained beyond the reasonable needs of the business.

Historical Context

The classification of Personal Service Corporations was established to prevent tax avoidance by high-income professionals who might otherwise tax shelter their income within corporate structures.

Applicability and Real-World Examples

Example 1: Law Firm

A law firm structured as a PSC ensures all income generated from legal services is taxed uniformly. The firm’s partners who actively participate in providing these services must own more than 95% of the corporation’s stock.

Example 2: Medical Practice

A medical practice where physician-owners provide medical services can be classified as a PSC. The income generated from medical consultations, surgeries, and treatments would be subject to the PSC taxation rules.

Comparisons with Other Corporations

Standard Corporations

Tax Rates: Unlike PSCs, standard corporations can benefit from graduated tax rates.
Ownership Flexibility: Ownership in standard corporations does not need to meet the stringent involvement criteria as PSCs.

S-Corporations

Pass-Through Taxation: Unlike PSCs, S-Corporations allow income to be taxed at the individual shareholder level.
Ownership Restrictions: S-Corporations have limitations on the number and type of permissible owners.

Professional Corporation (PC): A Professional Corporation (PC) is similar to a PSC but may not be subject to the flat tax rate. PCs encompass broader professional practices and have varying state-specific regulations.
Limited Liability Company (LLC): An LLC can consist of various professional services but benefits from pass-through taxation, different from PSCs’ flat corporate tax rate.

FAQs

What are the primary fields covered by Personal Service Corporations?

Personal Service Corporations generally cover fields such as accounting, law, medicine, engineering, and the performing arts.

How does the tax rate for Personal Service Corporations compare to other corporation types?

Personal Service Corporations are typically taxed at a flat rate of 21%, similar to standard corporate tax rates, but they do not benefit from graduated tax brackets.

Can a Personal Service Corporation deduct business expenses?

Yes, PSCs can deduct necessary and ordinary business expenses, but salary deductions to shareholder-employees must be reasonable.

References

IRS Guidelines on Personal Service Corporations
Tax Code Sections Governing PSCs
Relevant case law and scholarly articles on corporate tax practices.

Summary

A Personal Service Corporation (PSC) is a specialized corporate structure providing personal services in fields like law, health, and engineering. It is subject to distinct tax regulations, including a flat tax rate, to ensure compliance and prevent tax avoidance. Understanding the definition, key features, and tax implications of PSCs is crucial for professionals contemplating this corporate structure.