Operating a Personal Service Corporation
| Publication year | 1988 |
| Pages | 2011 |
| Citation | Vol. 17 No. 10 Pg. 2011 |
1988, October, Pg. 2011. Operating a Personal Service Corporation
Professionals have long sought the advantages of practicing in corporate form.(fn1) Until recently, incorporation of a professional practice was primarily tax motivated because it afforded its owneremployees significant tax benefits. These benefits included more favorable qualified retirement plans and fringe benefits, a limited ability to accumulate income at lower marginal rates, and deferred-income recognition when the personal service corporation and its owners-employees had different tax year-ends. The concept of limited liability rarely entered into the decision-making process.
Recent amendments to the Internal Revenue Code of 1986, as amended ("Code"), particularly the Revenue Act of 1987,(fn2) have lessened tax advantages and, therefore, made limited liability one of the most significant advantages of the corporate form. This article examines aspects of limited liability and the effects of recent tax changes on personal service corporations.
For years, the Internal Revenue Service ("IRS") aggressively but unsuccessfully attacked the use of the corporate form by professional service providers through legislation and in the courts. Initially, the IRS sought to ignore the existence of the corporation as a separate entity by using the assignment of income doctrine under Code § 482(fn3) and amendments to the regulations defining when an association is taxable as a corporation.(fn4) These methods, as well as legislative changes,(fn5) proved ineffective even when dealing with the more "abusive" partnerships of professional corporations.
However, the IRS may have found an effective tool with elimination of the graduated or marginal rates for personal service corporations.(fn6) The cumulative effect of indirect efforts to discourage the use of professional service corporations and the elimination of their graduated income tax rates have caused tax practitioners to rethink the value of using personal service corporations.(fn7)
In Colorado, the advantage offered a licensed professional practicing as an employee of a professional corporation still may tip the scale in favor of the use of a personal service corporation. Corporate insulation from liability has been extended to professional owner-employees, at least for obligations of a purely business and non-professional nature.(fn8) Further, the Colorado statutes permitting professionals to form corporations for the practice of the licensed professions and occupations usually provide immunity from joint and several liability for the errors and omissions of other corporate employees, as long as adequate professional liability insurance is maintained.(fn9)
While the protection afforded an owner-employee of a professional corporation from claims of business creditors and tort claimants provides some comfort, it does not extend to direct tort claims against the owner-employee for his or her own malpractice or for negligent retention, hiring or supervision of another negligent corporate employee. In addition, business creditors, such as landlords, equipment lessors or lenders, generally insist upon personal guarantees by the owner-employees of personal service corporations (rather than looking only to the corporation's assets and credit) because such corporations are not usually capital intensive.
Further, the federal bankruptcy laws distinguish between corporate-sponsored qualified plans and individual- and partnership-sponsored plans. Under these laws, a participant's interest in a corporate-sponsored qualified plan is more likely to be exempt from inclusion in a bankruptcy estate because of the spendthrift trust requirements. When a significant portion of a professional's assets consist of interest in a qualified plan, the possible advantage of having a corporate-sponsored qualified plan often weights the decision in favor of incorporation.(fn10)
The Colorado legislature recently amended its exemption statute hoping to extend the state's exemption from inclusion in the bankruptcy estate to all pension, profit sharing and non-qualified deferred compensation plans and IRAs.(fn11) However, the statute can be interpreted as exempting only a portion
For a personal service corporation, then, the recent tax legislation requires careful attention to the tax profitability of operating as a C corporation and the form of the corporation's shareholder agreements and fringe benefit plans. Additionally, the accounting problems inherent in operating with a tax year other than a calendar year will be significant.
Most existing personal...
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