| A corporation whose employees/owners provide personal services in the fields of accounting, actuarial science, architecture, consulting, engineering, health, and the performing arts is a personal service corporation. An employee/owner is defined by the Internal Revenue Service as an individual who owns, either directly or indirectly, more than 10 percent of the outstanding stock of the corporation on any day of the tax year.
If a personal service corporation was formed for the principal purpose of avoiding or evading federal income tax by reducing the income of an employee/owner or by providing tax benefits to any employee/owner that would not have otherwise been available, the IRS is authorized to reallocate income, deductions, and other tax attributes between the corporation and the employee/owner. In determining whether a corporation was formed to evade or avoid taxes, the IRS will look for a reduction in the tax liability of the corporation or an increase in the tax benefits to any employee/owner.
The IRS is only permitted to make these allocations when substantially all of the personal corporation's services are performed for one other entity. Therefore, if a personal service corporation provides substantially all of its services to the general public, it is not subject to income allocation rules.
Prior to the enactment of this allocation statute, various courts permitted individuals to form personal service corporations that served no meaningful purpose other than to secure tax benefits such as defined benefit pension and liberal medical reimbursement plans that would not have otherwise been available. Although the IRS sought to tax the employee/owners directly on the income of the personal service corporations, courts determined that this attempt to shift the income to the individuals was not allowed because it was arbitrary and capricious.
Copyright 2010 LexisNexis, a division of Reed Elsevier Inc. |