What Is a Personal Corporation: Everything You Need to Know
What is a personal corporation? If you want your business to exist as an independent legal entity, a corporation is one of the best business entities to choose.3 min read
The Internal Revenue Service (IRS) offers a variety of tax options that business owners can choose based on their business types and circumstances. One of the most preferred tax statuses is the corporation. Business owners can also choose a personal service corporation if they meet the requirements.
What Is a Personal Service Corporation?
According to the IRS, a personal service corporation is an organization whose primary activity is to offer personal services delivered by its employee-owners. Personal services might include:
- Actuarial science
- Health, including veterinary services
- Performing arts
Based on the definition above, law firms, physician practices, vet clinics, and dance studios all qualify to file for personal service corporation status. However, employee-owners must have the necessary professional licenses from the state in which they operate. A corporation must meet certain requirements to be eligible for personal service corporation, including:
- Fifty-one percent of the corporation's service during a given tax year must be personal services.
- The corporation's employee-owners must have performed more than 20 percent of the value of the organization's provided services.
- On the last day of the tax year, the employee-owners must hold more than 10 percent of the corporation's outstanding stocks fair market value.
Tax Treatment on Personal Service Corporations
Unlike the graduated tax rate structure applied to other corporations, personal service corporations are subject to a flat 35 percent tax rate. Also, the IRS allows personal service corporations to use the cash accounting system even if they earn more than $5 million a year. If a personal service corporation is using the cash method, the IRS lets it deduct interest and the business expenses it owes employee-owners. Personal service corporations can also deduct losses arising from the sale or transfer of property between the company and an employee-owner.
This arrangement is ideal for high net income personal service corporations because it restricts their tax rate to 35 percent. However, it might not be wise to operate as a personal service corporation if your net income qualifies you for lower tax rates.
Restrictions on a Personal Service Corporation
Personal service corporations can only use a calendar year as their fiscal year. However, they can choose a fiscal year by filing Form 1128 or Form 8716, which allows them to adopt, change, or retain a tax year or elect to have a different tax year, respectively. The IRS must approve the request formally after the company files any of these forms. However, the IRS can restrict deductions for a specific amount paid to employee-owners if a personal service corporation files Form 8716.
How to Form a Personal Corporation
To establish a personal corporation, you must:
- Choose a state of incorporation. While many business owners choose their home state for incorporation, many incorporate their businesses in corporate havens such as Delaware, Nevada, and South Dakota.
- Decide on a corporate name. Be sure to choose a name that has not been registered before in your state of incorporation.
Personal service corporations offer several fringe benefits. For instance, these corporations can:
- Provide medical plans to cover their employees.
- Provide employees with tax-sheltered pensions such as individual retirement accounts (IRAs).
- Buy insurance to cover anything from their employees to equipment, life insurance, disability insurance, and more.
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