A PSC to call your own
By Mark E. Battersby

Many chiropractors have incorporated their practices, if only because of liability concerns. A large number of those incorporated entities involve the services of the practice’s principal or principals, so the ever-vigilant Internal Revenue Service frequently labels them “personal service corporations.”

This is a designation that a surprising number of chiropractors have not found to be a deterrent.

Identifying certain personal services corporations (PSCs) as “qualified” and taxing them at a flat rate of 35 percent was our lawmaker’s way of reducing incentives for professionals to shelter part of their income in a corporate form with a lower marginal rate.

However, PSCs remain popular, because they afford chiropractors protection against many forms of liability — and continue to provide tax benefits. However, you should be aware that the IRS does use the PSC rules to combat perceived abuses.

A PSC FOR EVERY PRACTICE

Personal service corporations date back to a time when the top tax rate for individual income was much higher than the rate for corporations. This provided an incentive for many professionals to incorporate their practices to win the benefits available to employers or corporations.

In general, a personal services corporation is a regular C corporation in which personal services (health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting) are performed by employee-owners.

It pays a flat tax rate at the highest marginal rate (currently 35 percent), instead of paying the graduated tax rate a regular C corporation pays. Because of the stiff 35 percent flat tax on a PSC’s taxable income, corporations generally try to distribute all profits in the form of wages to the employee-shareholders performing the services.

This, in effect, eliminates the negative results caused by the flat 35 percent tax.

Remember, however, the IRS often challenges the amount paid as wages to employee-owners of PSCs. The agency then tries to reclassify wages as dividend distri-butions under the premise that the wage is not reasonable.

If successful, the IRS reclassification can result in an increase in taxable income, because dividend distributions are not deductible by the corporation.

GROUP PRACTICES

Professionals in group practices are often concerned about liability exposure for the malpractice of their co-owners. Although a PSC, LLC, or S corporation may shield you from claims against your personal assets, the assets within the practice are still at risk. For this and other reasons, professionals often form multiple personal service corporations when engaging in group practice.

Generally, each professional forms a separate PSC in which the individual owns 100 percent of the stock. The overall group practice is then organized as a firm under one of the following methods:

• Each personal service corporation owns a partnership interest in a firm organized as a partnership; or

• Each personal service corporation is a member of a firm organized as an LLC; or

• Each professional owns stock in an S corporation. In turn, the S corporation contracts with the separate personal service corporations for professional services.

SOME BENEFITS

PSCs can provide professionals with fringe benefits that are not available under an S corporation, LLC, or partnership entity form. As with the LLC or S corporation option, assets held in the individual PSC are protected from claims against the firm resulting from malpractice of other professionals in the firm.

If you are incorporated as a PSC, either you or the PSC can own assets, hire employees, and incur various expenses.

If you are a PSC in a group, this means that you can:

• Purchase equipment you need that would not be used by other professionals in the firm and avoid controversy,

• Make independent decisions in your area of specialty,

• Allocate discretionary expenses to you rather than have the expense imposed on the firm as a whole,

• Admit a new member to the firm as a tax-free event for the new member.

AVOIDING IRS RECLASSIFICATION

The IRS may attempt to disregard the solely owned personal service corporation and allocate its income to its sole employee/shareholder. (See sidebar “A PSC court case.”) To avoid the reclassification, you need to set up the PSC so that tax avoidance is not the primary reason for the organizational structure.

Also, keep in mind that the relationship between the individual professionals and a group practicing as a firm should not have the appearance of an employment arrangement.

Professional athletes, entertainers, as well as many chiropractors and other professionals, have long benefited from the professional services corporation entity. Whether to avoid having the chiropractic practice labeled as a PSC by the IRS to benefit from its remaining tax benefits, or merely because it affords some protection against liability, the PSC entity deserves careful consideration.

SIDEBAR:
A PSC court case

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

Disclaimer: The author is not engaged in rendering tax, legal, or accounting advice. Please consult your professional advisor about issues related to your practice.