C Corporations don’t work for everybody. In fact, there are two cases where you probably won’t want to use a C corporation.
First, if you have a personal holding company, you’re going to pay a higher tax rate. There are two tests for a personal holding company. You have to say ‘yes’ to both to have a personal holding company.
Is 60% or more of the gross income from passive sources? This includes rent, royalties and the like.
Is 50% or more of the ownership owned directly or indirectly by 5 or less individuals? (If an individual owns a corporation, that counts as indirect ownership.)
Additionally, if you’re holding property that you expect to appreciate, you’ll pay more tax if it’s within a C Corporation.
Rule #1: Don’t use your company as a personal holding company, unless there is a really compelling reason to do so. And then even if you think you have a compelling reason, double check with a CPA and/or tax attorney who is experienced in this area to make sure you’re right.
Rule #2: Don’t put appreciating property inside a C Corporation. Again, even if you think you have a great reason, get solid advice first.
Personal Service Corporations (PSC) pay at a higher rate then regular C Corporations. The actual term used by the IRS is “qualified personal service corporation” and includes anyone who uses a C Corporation performs health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting.
There is a possible out, though. If you meet one of the follow two tests, then you are not a PSC, in the eyes of the IRS.
- If 5% or more of the stock is owned by employees or others who do not perform the personal services.
- If 20% or more of the activities done by employees are not related to the personal services.
Rule #3: If you’re a PSC and you can’t get out of the test by activities or ownership tests, consider a different structure. Otherwise, you’ll need to make sure you never leave profit in the company. That usually means taking a larger salary and paying more than you need to in payroll taxes.
Check out the next post in this series. Learn about the big myth of C Corporations.