Taxation of Personal Service Corporations

Although most corporations are entitled to calculate their tax using graduated rates, there is an exception for "qualified personal service" corporations, which are subject to a flat tax rate of 35 percent. A corporation is a qualified personal service corporation if it meets both of the following tests:

Substantially all of the corporation's activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, and
At least 95 percent of the corporation's stock is owned by employees performing services for the corporation, retired employees, the estates of employees, or other persons acquiring stock in the corporation by reason of the death of employees.

The Internal Revenue Service has begun searching for qualified personal service corporations that are not using the mandatory flat taxation rate and contacting them by letter. Personal service corporations that receive a letter have 30 days to either agree or disagree with the proposed tax increase. The tax increase will be the difference between the flat 35 percent rate and the tax shown on the original return.

Taxpayers who do not agree may challenge the determination by providing a written statement that they do not agree, the reasons for disagreement, and the law or other authority that supports their position.