According to IRS, the C corporation can only qualify to be a personal service corporation if its members (the professionals) own over 10% of the stock and should provide not less than 20% of personal services for the corporation. Back To: BUSINESS ENTITIES, CORPORATE GOVERNANCE, & OWNERSHIP How Does a Personal Service Corporation Work?
How much stock should an employee own in a personal service corporation?
The employee/owners must also own at least 10% of the outstanding stock of the personal service corporation on the last day of the initial one-year testing period. 1 A personal service corporation is a taxing entity set up under IRS regulations.
What is the ownership requirement of stock in a company?
The ownership requirement is typically defined as either a multiple of salary/retainer or a fixed number of shares. The majority of companies will require that a specified value of stock expressed as a multiple of salary (or retainer for directors) be held by each participating executive.
Who can own S corporation stock?
The only people allowed to own S corporation stock are those who are either a U. S. citizen or someone who is a U.S. permanent resident. A non-resident is specifically prohibited from owning S corporation stock. If someone were to sell any of their shares of the S corporation to a non-resident, the company would lose its S corporation status.
What are the requirements for a C corporation to be personal service?
For these C Corporations to be considered a personal service corporation by the IRS, the employee-owners must perform at least 20% of the personal services themselves. The employee/owners must also own at least 10% of the outstanding stock of the personal service corporation on the last day of the initial one-year testing period. 1
What qualifies as a personal service corporation?
For a corporation to be considered a personal service corporation by the IRS, the employee/owner must perform at least 20% of the personal services themselves, and must also own at least 10% of the outstanding stock in the testing period.
What type of corporation is a personal service corporation?
They are an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if they are an independent contractor for other purposes) on any day of the testing period. They own any stock in the corporation at any time during the testing period.
What does the IRS consider personal services?
This category of pay includes payments for professional services, such as fees of an attorney, physician, or accountant made directly to the person performing the services.
Who is subject to personal holding company tax?
Since the PHC tax applies only to C corporations in which more than 50% of the value of stock is owned by five or fewer individuals during the last half of the tax year, you can avoid PHC status by ensuring that the top five owners in your closely held corporation own less than 50% of the value of the outstanding stock ...
Can a PSC be an S corp?
Personal service corporations with eligible shareholders may elect to be taxed as S corporations.
What is the difference between a personal service corporation and a qualified personal service corporation?
There is a difference between the tax rates for personal service corporations (PSCs) and Qualified PSCs. PSC are taxed using the same tax tables as a regular 1120 corporation. Qualified PSC are taxed at a flat 35% rate.
How do I avoid personal service corporation status?
The obvious way to avoid being deemed a Personal Services Corporation is also not really an option for many small corporations: ensure that your corporation has more than 5 full-time employees throughout the year, and/or provide your services only to an associated business.
What are personal services examples?
Personal services include, but are not limited to, legal, accounting, management consulting, investment banking, planning, training, statistical research, public relations, architectural, engineering, surveying or any other services of a consulting, technical or professional nature.
Can a personal service corporation have a fiscal year end?
Electing a fiscal year under Sec. 444(b)(1)). Since the required year end for PSCs is a calendar year end, only September, October, and November year ends can be elected pursuant to Sec. 444. Practice tip: As a practical matter, most existing PSCs use a calendar year and will not be able to make a Sec.
Is my corporation a personal holding company?
A corporation will be considered a personal holding company if it meets both the Income Test and the Stock Ownership Test. The Income Test states that at least 60% of the corporation's adjusted ordinary gross income for the tax year is from certain dividends, interest, rent, royalties, and annuities.
What is the difference between a holding company and a personal holding company?
A personal holding company (PHC) is often referred to as a “Holdco” or “Investment Holding Company”. A PHC is not a defined term in the Income Tax Act, but rather a term adopted to define a corporation which holds assets; typically income-generating investment assets.
What is the purpose of a personal holding company?
A personal holding company (PHC) is known as a C corporation formed for the purpose of owning the stock of other companies; therefore, the holding company doesn't offer products or services but merely owns the shares of other corporations.
Who must hold all or nearly all of the corporation's stock?
However, either the owner/employee or their family members must hold all or nearly all of the corporation's outstanding stock. This rule does not apply to other types of personal service corporations.
What is a personal service corporation?
A personal service corporation is a taxing entity set up under IRS regulations. The services provided by a personal service corporation may include any activity performed in the following fields: accounting, engineering, architecture, consulting, actuarial science, law, performing arts and health, including veterinary services. Financial services activities are not considered qualified services (which is why many financial advisers choose to organize as S Corporations ). An income test requires that employees of personal services corporations must spend at least 95% of their work time on qualified services.
What is an employee of a corporation?
They are an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if they are an independent contractor for other purposes) on any day of the testing period. They own any stock in the corporation at any time during the testing period. If individual functions as the owner/employee ...
Is financial services considered qualified services?
Financial services activities are not considered qualified services (which is why many financial advisers choose to organize as S Corporations ). An income test requires that employees of personal services corporations must spend at least 95% of their work time on qualified services.
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Will Kenton has 10 years of experience as a writer and editor. He developed Investopedia's Anxiety Index and its performance marketing initiative. He is an expert on the economy and investing laws and regulations. Will holds a Bachelor of Arts in literature and political science from Ohio University. He received his Master of Arts in economics at The New School for Social Research. He earned his Master of Arts and his Doctor of Philosophy in English literature at New York University.
Is a personal service corporation stock deductible?
They own any stock in the corporation at any time during the testing period. If individual functions as the owner/employee of a personal service corporation and their primary business is related to creative/fine arts or photography, any current expenses they incur pursuant to creative work are deductible for the corporation.
What is the ownership requirement for a company?
The majority of companies will require that a specified value of stock expressed as a multiple of salary (or retainer for directors) be held by each participating executive . Given that share price can fluctuate over time, changing the value of the shares held, many companies will use an average share price (i.e., 90 days or 180 days) to calculate the value of shares held. A common executive ownership requirement framework would be as follows:
How long does it take to get ownership of a company?
Most companies will allow executives and directors a period of time to reach ownership requirements. By far the most common window period is five years. This window period would begin when a new ownership guideline is established or amended, or when a new participant is added to a guideline.
What is outright ownership of stock?
Outright ownership of company stock is universally deemed to be ownership under stock ownership guidelines. A majority of companies expand the ownership definition to also include shares held in retirement accounts and unvested restricted shares, RSUs and deferred shares. A small minority of companies will allow for other forms of equity to be counted toward ownership, such as vested stock options or unpaid performance shares.
How can a group of professionals become a corporation?
Groups of professionals can become corporations by registering with a state to perform professional services. The professional corporation can then meet IRS qualifications to have beneficial tax status as a personal service corporation. Only certain types of professionals can have personal service corporation status.
What is a professional corporation?
Professional corporations (PCs) are groups of professionals who register with their state as this type of business entity. Some states require the professionals to be certified by the profession's state regulatory board, and others limit the types of professionals that can form PCs.
What is a PC corporation?
A PC is a corporation composed of specific types of professionals, set up according to state law. After forming the PC, the corporation can be qualified by the IRS to have PSC tax status. This article explains how PCs and PSCs work for owners and their businesses.
What is the corporate rate for a PSC?
Professional corporations pay taxes as corporations, which means the corporation pays tax at the corporate rate of 21%. Owners are shareholders who pay tax on the dividends they receive. If a PSC meets all of the IRS qualifications, it can be classified as such for tax purposes. 6. Personal service corporations also pay corporate taxes at ...
How are corporations formed?
Corporations are formed by registering with a state. The process is different for each state, but it usually involves filing an application—called articles of incorporation —with the state's business division (usually part of the secretary of state's office ).
What is the disadvantage of a professional corporation?
The main disadvantage of the professional corporation is that income is taxed at the corporate tax rate of 21%. As noted above, the employees pay tax on their income as employees.
Can a financial services professional be a PSC?
For example, financial services professionals can register as a PC in some states, but they can't form a PSC.
What is PHC tax?
The PHC tax is a 20% tax imposed for each tax year on a PHC's undistributed personal holding company income (UPHCI). A PHC is a corporation that is not an excluded corporation and meets (1) the stock ownership requirement and (2) the income requirement. Excluded corporations include, for example, Sec.
Is a closely held corporation subject to PHC tax?
Tax practice reminders and best practices. The best result for any closely held corporation potentially subject to the PHC tax is that the tax simply does not apply because the corporation is not a PHC.
Is PHC tax self assessed?
In contrast to the AET, which is assessed by the government, the PHC tax is self - assessed on Schedule PH. As discussed, this self - assessment can be prevented by ensuring the corporation either does not meet the stock ownership test or does not meet the PHC income test.
What is the purpose of the post on stock ownership?
The purpose of this Post is remind publicly-traded companies to revisit their stock ownership policies to determine whether a temporary waiver of the policy requirements is advisable. This Post is Part 5 of a 7-Part series addressing compensation adjustments that Compensation Committees could consider in order to continue to incent and retain their executive officers in today’s economy.
What is equity ownership policy?
Equity ownership goals within stock ownership policies are typically denominated in shares or dollars (the latter being a fixed dollar amount or a percentage of compensation). Dollar-denominated guidelines are the most common among publicly traded companies, and many of these guidelines are based upon a percentage of base salary. For those companies where compliance with their stock ownership guidelines is denominated in dollars, any significant drop in stock price is likely to cause the executive to fail the policy’s requirements.
How often do companies measure stock ownership?
Exactly when and how ownership levels are measured varies considerably. Companies typically attempt to measure stock ownership levels at least annually. However, we have also seen companies provide for a recalculation anywhere from quarterly to every three years. Some even simply indicated they recalculate “periodically” or “regularly.” Because ownership will almost always include shares owned directly and indirectly by the executive (and often immediate family members and certain trusts), a company may need to solicit information from the executive confirming total ownership.
Why do companies need to confirm total ownership?
Because ownership will almost always include shares owned directly and indirectly by the executive (and often immediate family members and certain trusts), a company may need to solicit information from the executive confirming total ownership. The means by which stock price is measured is important.
How do RSUs help executives?
The increased utilization by many companies of RSUs is helping executives meet their ownership requirements. In addition, allowing the deferral of salary or bonus into plans with a stock-based, notional investment option or the deferral of equity-based awards—such as restricted stock units (RSUs) or performance shares or units—can also help executives meet ownership targets. In fact, using such units can make sense for an executive attempting to meet a guideline because they are a means of pre-tax savings (like shares held in a 401 (k) plan), so can “cost” less than acquiring shares by other means. Finally, the use of time or performance-based, full-value stock incentives settled in stock continues to help executives achieve required targets.
What is the SEC requirement for public companies?
The Securities and Exchange Commission (SEC) requires public companies to disclose details of their executive stock ownership and retention guidelines in the Compensation Discussion and Analysis (CD&A) section of proxy statements. Holdings required of non-employee directors are also provided in the proxy.
How long does it take to meet ownership targets?
Monitoring Compliance. In most cases, executives are required to meet their employer’s ownership targets within a five-year period, but often no period is stated due to the retention requirements. In our review, timeframes to meet the targets ranged from three to seven years.
What is the 3rd tier of a company?
The “3rd Tier” are executive officers, such as senior vice presidents. The “4th Tier” are commonly vice presidents or “other” senior executives. While 72% of the companies we tracked have at least three tiers in their guideline structure, nearly 30% have four (or sometimes more) tiers.
Do non-employee directors need to be held in proxy?
Holdings required of non-employee directors are also provided in the proxy. Companies typically also describe the status of executives and directors as they pertain to compliance with the guidelines. Most companies with executive stock ownership targets continue to use a “multiple of salary” approach.
How many shareholders are allowed in an S corporation?
While under normal conditions only 100 shareholders are allowed to be part of an S corporation, an exception by the Internal Revenue Service allows family members to be counted as one shareholder. Family members include children and spouses.
What happens if a S corporation violates the eligibility restrictions?
On the downside, if the corporation violates any of the eligibility restrictions, it will lose its S corporation status and be taxed as a regular corporation. An S corporation can have no more than 25 percent of its income generated by passive activities.
Is a 2553 a domestic corporation?
The company is either a domestic entity or domestic corporation eligible to file Form 2553 and be treated as a corporation. In regard to the 100-shareholder limit, husbands, wives, and their estates are treated as one shareholder. A family member can opt to treat all family members as one shareholder.
Can a non-resident own S corporation stock?
A non-resident is specifically prohibited from owning S corporation stock. If someone were to sell any of their shares of the S corporation to a non-resident, the company would lose its S corporation status. The tax code has additional limitations of other situations that forbid owing S corporation stock.
Can a family member be a shareholder?
A family member can opt to treat all family members as one shareholder. A company cannot be an ineligible corporation. Ineligible corporations include businesses such as a bank or thrift institution. It is ineligible if it is an insurance company that is taxed under Subchapter L of the U.S. Code.
Can insurance companies be shareholders?
Certain insurance companies and financial institutions cannot be shareholders regardless of how the business structure is organized. S corporations have one class of stock. What this means is a corporation can't have shares of stock with different dividend rights or liquidation preferences.
Can an estate own stock after bankruptcy?
For estates involving someone who owned stock, the shares will continue to be owned by the estate. Also, a shareholder experiencing individual bankruptcy retains his shares. Certain trusts are also eligible to own S corporation stock.
Terminology
Types
Summary
- A professional corporation (PC) is a corporation of professionals, organized (incorporated) under the laws of a specific state. In some states, some professionals are permitted to form corporations under specific regulations, to allow the professionals to have the benefit of a corporation while limiting liability in certain situations.
Risks
- In a corporation, the shareholders and officers are free from personal liability, but this would be a problem for a corporation formed by professionals if they formed the corporation in order to absolve themselves of responsibility for their professional actions (malpractice).
Operation
- A professional corporation must form a corporation within a state. It is not an LLC or a partnership, and it is taxed as a corporation. A PC is taxed like other corporations at the current flat rate of 21 percent. The owners perform work in their professional capacity as employees; this work must be fairly compensated and it is taxed at the employee's tax rate. The owners pay FIC…
Ownership
- A PC can elect S corporation status, in which case the profits are passed on to shareholders. Ownership: The employee-owners must \"own more than 10% of the fair market value of its outstanding stock.\"
Qualification
- The PC must identify itself as a \"PC\" or \"P.C.\" in its name, and all owners must be in the same profession, and all owners must be licensed in the state. Some states require that the professional corporation must have approval from that state's licensing board.
Advantages
- 2. Liability protection. The other advantage is that the PC form does not allow professionals to be free from personal liability from the result of his or her professional actions, but it does allow other shareholders or directors to be protected from the actions of another. This is typically the reason professionals form PC's.
Issues
- 3. Income Taxes. The main disadvantage of the professional corporation is that income is taxed at the corporate tax rate of 21%. As noted above, the employees pay tax on their income as employees.
Overview
- A personal service corporation (PSC) is a specific taxing entity recognized by the IRS. The IRS requirements for a personal services corporation are (over-simplified):
Activities
- Principal activity. The principal activity must be providing personal services, in the fields of \" accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing art.,\" and that
Business
- in the same way as Professional Corporations, the business can pay shareholders fo their work as employees, taking a deduction for employee wages and benefits, and reducing corporate income.