812 / How is a “personal service corporation” taxed?

Prior to 2018, certain personal service corporations were taxed at a flat rate of 35 percent.¹ In effect, this meant that the benefit of the graduated corporate income tax rates was not available. For tax years beginning after December 31, 2017, personal service corporations are taxed at the 21 percent corporate rate.

A personal service corporation for this purpose is a corporation in which substantially all corporate activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. In addition, substantially all of the stock must be owned (1) directly by employees, retired employees, or their estates or (2) indirectly through partnerships, S corporations, or qualified personal service corporations.²

IRC Section 269A permits the IRS to reallocate income, deductions, credits, exclusions, and other allowances (to the extent necessary to prevent avoidance or evasion of federal income tax) between a personal service corporation (PSC) and its employee-owners if the corporation is formed for the principal purpose of securing tax benefits for its employee-owners (i.e., more than 10 percent shareholder-employees after application of attribution rules) and substantially all of its services are performed for a single other entity. For purposes of IRC Section 269A, a personal service corporation is a corporation the principal activity of which is the performance of personal services and such services are substantially performed by the employee-owners.³ A professional basketball player was considered to be an employee of an NBA team, not his personal service corporation, and all compensation from the team was taxable to him individually, even though his PSC had entered into a contract with the team for his personal services.⁴