Tax Court Rules C-Corp Is Not a Qualified Personal Service Corporation

When is an accounting firm not a qualified personal service corporation (QPSC)? According to Judge Holmes of the U.S. Tax Court, it is when the accounting firm’s employees spend less than 95 percent of their time on accounting and accounting related tasks, even if they are nominally the employees of a financial and investment services firm.


Advertisement


All Aboard the High-Velocity 2006 FRx Express! FRx Software has the engine fired up again to travel nationwide with timely training and expert guidance! Microsoft FRx and Microsoft Forecaster users, potential users and resellers don’t miss this FREE*, half-day event!

Once you’re on board, the FRx Software experts will help you gain tremendous insight into Microsoft FRx and Microsoft Forecaster. You’ll have the opportunity to hear customer perspectives and network with prospects plus pack in useful tips, and see the features and benefits of FRx Software’s financial analytic applications. Register now!


FRx Software Home Product Information
Training & Consulting Product Demo
Webcast Customer Testimonial Video



The case of Ron Lykins, Inc. v. Commissioner of Internal Revenue began in 2000 when Ronald Lykins, sole owner of Ron Lykins, Inc., a well-established accounting and financial services firm in central Ohio, split off the financial advisory business into a new company, Lykins Financial Group, LLC. This left Lykins, Inc. selling accounting services exclusively.

The decision to split the firms left Lykins in a challenging position, potentially increasing his tax liability if it was determined to be a QPSC. If the accounting firm was not determined to be a QPSC, the split would allow Lykins to market his businesses to a wider variety of buyers when he retires.

“If caught as a personal service firm, the split was a bad idea,” Bob D. Scharin, Senior Tax Analyst, RIA, a Thomson business and provider of tax information and software to tax professionals, told AccountingWEB. “The split was probably tax neutral the way things turned out.”

After audits in 1999 and 2000, the Commissioner argued that the split made Lykins, Inc., which was structured as a Subchapter C corporation, a QPSC subject to taxation at a flat rate of 35 percent in 2000. In the Commissioner’s favor was the fact that splitting the income generated by both firms was simple. Lykins Financial’s income came exclusively from commissions on the sale of securities and investment advice. Lykins Inc.’s income came exclusively from fees charged for tax preparation and advice. Some employees also worked exclusively for one firm or the other. Both firms filed separate corporate tax returns.

Other aspects of separating the firms, however, proved more difficult. Lykins was the owner of both companies. Both firms share the same office space; address; phone number; copy and fax machines; employee manual; and even coffee-maker. There is no written agreement defining which firm employees worked for and some employees did work for both. Overhead services, including reception, payroll, and rent for both firms, were provided Lykins Inc..

For Judge Holmes, the decision came down to the issue of whether employees of the corporation spent 95 percent of their time engaged in activities of a qualifying field, such as accounting. He found that simply allocating the costs of Lykins Inc. employees to Lykins Financial did not make them Lykins Financial employees when their wages, benefits, and taxes were paid by Lykins Inc.. Therefore, the determination of whether or not Lykins Inc. was a QPSC depended on the number of hours employees spent on accounting services and the hours spent on investment services. Since only 80.53 percent of employees’ time was spent on accounting services, Lykins Inc. is not a QPSC, and the decision of the Tax court will be entered for Lykins.

“Look at both the tax and non-tax implications when considering splitting a business into multiple firms,” Schrain advises. “Look at payroll tax implications since running payroll through two businesses may mean the employers’ share of FICA is greater. The costs of benefits may also increase with multiple employers.”

Although the taxpayer in this case had split activities into different entities, other accounting firms may choose to add to their service offerings without splitting up. As accounting firms increase their range of services to better meet client needs, these firms may find that their choice-of-entity considerations change. A firm, that previously would have been a QPSC if structured as a C corporation, may find that its additional services would allow it to be a C corporation without falling into the QPSC category. The case also serves as a reminder that busy tax professionals should consider all the ramifications of their own business activities with the same level of care that they would apply to advising their clients regarding similar business transactions.

You may like these other stories...

For the first time in the five-year history of Vault.com’s rankings of the top 50 accounting firms to work for in North America, a firm has held the top spot as best accounting employer for two consecutive years....
With tomorrow being Tax Day, you might see some procrastinators at your office filling out forms, printing out paperwork, or getting last-minute tax advice from their accountant so they can meet the IRS’s filing...
You can read volumes on how to manage an accounting practice. But if you want the quick version, just read the following four points. Everything else is just commentary.  (These points come out of the 1997 book, The...

Upcoming CPE Webinars

Apr 22
Is everyone at your organization meeting your client service expectations? Let client service expert, Kristen Rampe, CPA help you establish a reputation of top-tier service in every facet of your firm during this one hour webinar.
Apr 24
In this session Excel expert David Ringstrom, CPA introduces you to a powerful but underutilized macro feature in Excel.
Apr 25
This material focuses on the principles of accounting for non-profit organizations' revenues. It will include discussions of revenue recognition for cash and non-cash contributions as well as other revenues commonly received by non-profit organizations.
Apr 30
During the second session of a four-part series on Individual Leadership, the focus will be on time management- a critical success factor for effective leadership. Each person has 24 hours of time to spend each day; the key is making wise investments and knowing what investments yield the greatest return.