Qualified Personal Service Corporation

The IRS defines a qualified personal service corporation (sometimes called a QPS or a PSC) as a specific type of business where the owner/shareholder provides his or her own services for the corporation.

The IRS considers most professional corporations to also be personal service corporations. In addition, though, the IRS has recently added actuaries, performing artists, and consulting companies – businesses that generally aren’t required to be professional corporations – to the list.

Operating a PSC as a C Corporation is something to be avoided, if possible. A qualified PSC is subject to a flat tax of 35% on its earnings, and has a lower threshold for accumulated earnings tax than a regular C Corporation. Instead of working your way through the graduated tax brackets you go right to 35% on every profit dollar, which will make for a significantly higher tax bill.

Plus, a qualified PSC is also required to have a December 31st fiscal year-end, eliminating any tax-timing benefits normally available to C Corporations with staggered year-ends.

If you think your business might be considered a qualified PSC, you have two options. You can:

Operate as an S Corporation. The IRS considers the flow-through tax status of an S Corporation to offset the 35 percent rate it would normally levy; or

Try to fail the IRS qualified PSC test.

There are two ways to fail the test. One way is to show that less than 95 percent of all employees’ time is spent in PSC activities. For example, many veterinarians also offer animal boarding and care. As long as the veterinary practice can show that its employees are spending at least five percent of their time caring for boarded pets, the practice can operate as a C Corporation without being tagged as a qualified PSC. Now the veterinary practice can enjoy all of the standard C Corporation benefits.

We see this with optometrists too. Have you ever visited your eye specialist and been able to buy your glasses, frames and contact lenses on site as well? How about a chiropractor who also sells relaxation materials, a doctor’s office that sells vitamin supplements, and so on? The same theory is at work here – by offering services that are not PSC related, the owners can fail the personal service company test.

The second way to fail the test is to make sure that at least five percent of the PSC’S stock is held by persons who aren’t personally providing the professional service. If you’re lucky enough to be in a state that permits non-licensed spouses to also hold ownership in a professional corporation or professional LLC, this is easy – make sure your spouse (or spouses, if there are multiple owners involved) own five percent or more.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable. Got questions? Contact us! We’re here for you.

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