@071 CHAP 2 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � CHOICE OF ENTITY: PROFESSIONAL SERVICE � � BUSINESSES AND SIMILAR OPERATIONS � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� Traditionally, C corporations (professional service corpor- ations) have been the legal vehicle of choice for most providers of professional services, as well as some enter- tainers and professional athletes. This was primarily to take advantage of qualified pension and profit sharing plans, tax deductible fringe benefits (medical insurance, etc.), income deferral from using a fiscal tax year and low tax rates on net income retained by the corporation. Even professional partnerships were often structured so that the partners in the partnership were mostly or entirely profes- sional corporations set up by the individual professionals (primarily to take advantage of certain provisions of the tax laws regarding pension plans). Most of these excellent reasons for operating as C corpora- tions began to disappear in 1982. Since 1984, Keogh and S corporation pension and profit sharing plans have been given virtual "parity" with C corporation plans; the 1986 Act did away with fiscal years for most new personal ser- vice corporations and virtually prohibited the use of sep- arate pension plans for each corporate partner in a part- nership; and the Revenue Act of 1987 did away with gradu- ated tax rates for "qualified personal service corpora- tions," thus subjecting ALL taxable income of such corpor- ations to a flat rate tax of 34%, higher than the highest individual tax rate. (Of course, not all kinds of service businesses are subject to each of the above new restric- tions on personal service corporations, since the defini- tions vary slightly in each instance.) In addition, all C corporations are now subject to eventual double taxation on appreciated corporate assets when such corporations are eventually liquidated, and are potentially subject each year to alternative minimum tax where "adjusted current earnings" differ from regular taxable income for various corporate income and deduction items. Those corporations subject to the 34% flat tax rate must now also be very careful in paying out enough salary each year to zero out taxable income, to avoid paying this high tax rate. Also, where a new business is expected to operate at a loss for a year or more, such losses must be carried forward by a C corporation (for 15 years) until the corporation gen- erates enough income to use up the losses, or the carry- overs expire. For an unincorporated service business or one operating as an S corporation, these early losses may be used by the individual owners immediately to offset their other income of any kind. (These would not ordin- arily be considered passive losses.) Note, however, that for shareholders of an S corporation to utilize losses, their losses may be claimed on their individual tax returns only to the extent of their tax basis in their S corpora- tion stock, plus the amount of any loans they have made directly to the S corporation (simply agreeing to guarantee a loan made to the corporation by a lender will NOT give the shareholder any tax basis). Personal service corporations that are C corporations still enjoy an advantage over S corporations and unincorporated businesses with regard to deductibility of fringe benefits for employee-owners, though. However, the rules prohibit- ing discrimination against rank-and-file employees in cov- erage and benefits under these benefit plans have gradually been tightened in recent years. While it is not possible to make any blanket recommendation as to the legal form a new personal service business should adopt, most advisers today seem to agree that the typical professional service corporation should probably avoid C corporation status and should strongly consider becoming an S corporation or remaining unincorporated, instead. The deck has simply become too heavily stacked against most kinds of personal service corporations (other than S cor- porations). Where limited liability is important, an S corporation will now often be preferable to operating as a proprietorship or partnership. Note that in virtually all states, a "professional corporation" (medical, law, accoun- tancy, etc.) does NOT confer limited liability on its share- holders for purposes of malpractice claims, however. @IF173xx]Since your firm operates in a professional service business, @IF173xx]it is probable that a professional corporation wouldn't pro- @IF173xx]vide limited liability for @NAME. @IF175xx]PLANNING POINT FOR YOUR FIRM, @NAME: @IF175xx]旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� @IF175xx]쿍ecause your firm's business is consulting, however, rather� @IF175xx]퀃han being in a "profession" such as law of medicine, you � @IF175xx]퀂hould be able to obtain limited liability by operating the� @IF175xx]쿫usiness in corporate form, without being a "professional � @IF175xx]쿬orporation." � @IF175xx]읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴�