PSC & S election

[jmc]

Re: Rainbow Tax Service, Inc. vs. Commissioner, 128 TC 42

Did the corporation lose S election and assessed 35% PSC Tax because it operated disallowed tax service, or because any PSC can NOT elect S election and should stay as C Corp?

[veritas]

I don't recall any

mention of them electing S status.

[WhiteOleander]

A PSC is allowed the elect to become an S-Corp. Assuming they meet the requirements that anyone would have to meet.

[les grans]

QPSC - Yes; S corporation - No.

128 T.C. No. 5
UNITED STATES TAX COURT
RAINBOW TAX SERVICE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7738-05. Filed March 8, 2007.

Petitioner employed individuals to provide tax
return preparation and bookkeeping services.
Petitioner calculated its tax liability for
petitioner’s tax years ending June 30, 2002 and 2003,
using the graduated corporate income tax rates set
forth in sec. 11(b)(1), I.R.C.

Held: Petitioner’s tax return preparation and
bookkeeping services constitute accounting services for
purposes of sec. 448(d)(2), I.R.C., and petitioner is
therefore subject to the sec. 11(b)(2), I.R.C., flat
35-percent tax rate applicable to qualified personal
service corporations.


The corporation, Rainbow Tax Service, Inc., was not an S corporation. The court found that its accounting and bookkeeping services were among the type of services that causes a C corporation, such as Rainbow, to be a Qualified Personal Service Corporation, and to be liable for a "flat" 35% corporate income tax on its taxable income, instead of the graduated tax rates that apply to C corporations that aren't QPSCs. This doesn't have anything to do with being an S corporation, except that if Rainbow had made an S election, it wouldn't have found itself in Tax Court, because S corporations are not subject to the QPSC rules. And the tax preparation and bookkeeping services aren't "prohibited" in any way. Rather, they are - and were found by the court to be - among the eight "covered services" that will trigger liability for the flat tax rates to apply to QPSCs' taxable income.

[WhiteOleander]

Does anyone know why Congress taxes corps providing personal services so harshly?

I've always wondered about that.

[DaveinTexas]

I suppose

the reason the PCSs are taxed so harshly, flat 35%, because most PSCs are engaged in high revenue businesses and IRS wants a piece of that. Forcing a company to form a PSC guarantees that a lawyer/dentist etc can't just form a regular corporation, pay themselves a small salary and take advantage of lower graduated tax rates.

I know that some states require certain professionals to form a PSC, but then they can just elect S status and avoid the 35% tax altogether. It seems silly to me. There are only a handful of states that do not recognize S status corporations but that wouldn't stop me from making the election.

It all seems silly.