Personal Service Corporation
PERSONAL SERVICE CORPORATION (PSC)
A Personal Service Corporation — also known as a Professional Service Corporation, or a PSC — is a corporate entity formed by successful professionals who provide personal services to their clients. Businesses of this type include:
• Doctors, including dentists and veterinarians
• Accounting offices
• Law firms
• Business consultants
• Actuarial firms
• Performing arts businesses
REQUIREMENTS FOR PSC
For your business to qualify as a Personal Service Corporation, it must meet several requirements set in place by the IRS. These criteria must be satisfied during a “testing period,” which is often the previous year for tax purposes:
• You’re an employee-owner of your corporation, providing personal services for (or on behalf of) your corporation on the last day of the calendar year.
• During the calendar year, you and other employee-owners must perform a minimum of 20 percent of services in person.
• The principal activity of the corporation is providing “personal services” during the calendar year — all owner-employees must perform at least 20 percent of their business activities within the current tax year.
• The employee-owners must own more than 10 percent of the fair market value of any outstanding stock on the last day of the calendar year.
• You must conduct annual meetings and file annual reports — most states require annual meetings of shareholders and officers, with reports that must be filed with the Secretary of State’s office.
• Your company must file and pay annual franchise taxes — most states require payment of some corporate tax for the privilege of doing business in that state.
• You are required to maintain updated bylaws — the rules by which your corporation operates. They do not need to be filed, but must be kept by the officers of your corporation.
ADVANTAGES OF PSC
When your business forms a Personal Service Corporation, you enjoy a number of tax advantages. The law allows you, as an owner-employee, to provide tax-free life insurance and health insurance benefits to other employees. You can also offer fringe benefits, such as 401(k) retirement plans with higher limits on contributions than unincorporated businesses have. There are other benefits as well:
• Disability insurance is deductible
• Dependent care can be deducted
• Business travel is deductible
• Equipment purchases can be deductible
• Salaries and bonuses paid to owners and employees are deductible
• Profits from a closely held family business can be distributed to members of the family in the form of salary and fringe benefits
Through distribution to your shareholders, the profits of a PSC can be reduced to zero, thereby making the corporate tax liability zero. These advantages don’t exist for other types of business organizations, such as limited liability corporations (LLCs), partnerships or S corporations. If you have questions, contact us at Edofalltrades
For businesses such as a sole proprietorship, LLC or partnership, a death or desertion (if the owner leaves) means the business entity dissolves. A Personal Service Corporation, once formed, remains in existence as long as the requirements listed above are met. Ownership can be transferred, inherited or purchased.
Shares of stock can be transferred as well, with no change to the existing corporation. This is an advantage if you want to Succession Plan to your children or others. As long as you work 20 percent of the time for the business, even as an independent contractor, your PSC legally continues while the new owner-employees continue to do what’s needed to qualify under the rules. All owner-employees must continue to do their 20 percent of business in person to maintain their status as a personal or Professional Service Corporation.
KEEP YOUR PROFITS
The main advantage of a Personal Service Corporation over a limited liability corporation is the structure of the taxation. A PSC can help you retain company profits. Once the profits from your company are taxed, a PSC can retain up to $150,000 that otherwise has to be distributed to shareholders. This money can be used to pay for company improvements — such as facility renovations and upgrades, equipment purchases or other business transactions.
Your company can purchase items that increase productivity, efficiency or even office morale with the money you retain using this method. An LLC corporation doesn’t allow profits to be retained because all profits from the business must be distributed to the business owners to be taxed individually.
One of the drawbacks of forming a Personal Service Corporation as opposed to an LLC is the tax rate that your corporation receives. When an LLC is taxed, the profits are not taxed at the corporate level, but at individual levels. The profits from an LLC are only taxed once, on your individual tax return. A PSC has a more complex tax structure, and your corporation is actually taxed twice, once at the corporate level and again on at the individual shareholder level.
Another disadvantage of a Personal Service Corporation business model is the tax rate for your corporation. PSCs do not get the favorable tax rates that LLCs receive. Profits from PSC businesses are taxed at a flat 35 percent rate, regardless of the amount of profit the corporation made. An LLC, on the other hand, is taxed at 15 percent on the first $50,000 of profit. At 35 percent, the PSC often pays at a much higher rate on profits than the owners of an LLC pay on their individual shares of the profits.
GET PROFESSIONAL ADVICE
You have to legally file any changes you make to your company structure with the taxing authorities in your state. The rules for filing vary, depending upon where your business is based. Carefully consider all of your options before making any decision. Remember that the IRS is aware of any changes you make as well.
Before incorporating your business into a Personal Service Corporation or making any changes to the way your company is currently structured for tax purposes, talk to an accountant at Edofalltrades. We can tell you exactly what the advantages and disadvantages are for your individual situation. Get all the facts before you decide.