Magazine article The CPA Journal

Personal Service Corporations and the Employer Question

Magazine article The CPA Journal

Personal Service Corporations and the Employer Question

Article excerpt

As a result of RRA '93, the maximum marginal tax rates for individual taxpayers (39.6%) is higher than corporate taxpayers (35%). This difference is a factor to be considered when deciding whether to use the corporate format for conducting business. Use of a corporation enables deferral of some amount of tax, splitting of income,, and greater availability of fringe benefit provisions. Where an individual incorporates and derives revenue from the rendering of services, the corporation is commonly referred to as a personal service corporation (PSC). A controversial subject for PSCs that derive their revenue primarily from one client or customer is whether the shareholder-worker should be treated as an employee of the PSC or of the client (customer).

Employee of PSC or Third Party?

The IRS can seek to have income tax able to an shareholder-worker of a PSC rather than the PSC by either ignoring the PSC or having the amount reallocated to the shareholder-worker. Protecting recognition of a PSC is the long-held notion that a corporation that serves a business related function should be respected for tax purposes. The tax court has consistently held that determination of to whom amounts are taxable depends upon application of the common law factors for ascertaining whether a worker shall be deemed an employee of the PSC or the third party. Application of this approach is reflected in a trilogy of cases of which Leavell is the most recent.

Leavell: On January 31, 1995, the tax court in Leavell [104 T.C. No.6 (January 1, 1995)] held that amounts earned by a professional basketball player were directly taxable to him rather than his PSC. In Leavell, the taxpayer formed a PSC with which he then entered into a contract to render services. The PSC then entered into a contract with a professional basketball team (Houston Rockets), providing the shareholder-worker's services for a twoyear period. The contract was a standard NBA contract. To protect its rights, the team also had the player sign a guarantee.

Despite the apparent contract between the team and the PSC, the court found the player to be a common law employee of the team and, as such, held that all renumeration for his services were directly taxable to him. In reaching this decision, the court appeared to reject the position taken in Sargent, wherein the Eighth Circuit overturned a tax court decision and held amounts taxable to a PSC rather than an shareholder-worker.

Sargent: Sargent [919 F.ld 1151 (1990), rev'g 93 T.C. 571(1989)] involved a professional hockey player who formed a PSC with which he entered into a contract to perform services as a professional hockey player and consultant for a fixed salary. The PSC then entered into a contract with a professional hockey team pursuant to which the PSC would provide the team with the player's services in return for a salary. Both contracts were complied with. The player was covered by a deferred compensation plan provided by the PSC rather than the traditional NHL pension plan. Based upon these facts, the Eighth Circuit held that a principal-agency relationship between the PSC and player should be recognized, and the salary paid by the team attributed to the PSC. According to the Eighth Circuit, to adopt the position taken by the tax court in rejecting such recognition would both be-

* inconsistent with other tax court decisions that have found a principal-agency relationship, despite the presence of a common law employment relationship betTeen the service provider and third party; and

* inequitable in that it would enable a PSC of an independent contractor to estab lish a principal-agency relationship, but not the PSC of an employee.

Johnson: The Eighth Circuit decision in Sargent appeared to be influenced by the approach taken by the tax court in the 1984 case of Johnson [698 F.ld 371 (9th Cir.1981), aff g 78 T.C. 881 (1981)]. In Johnson, amounts paid by a team for the services of a professional basketball player were found to be directly taxable to the player rather than the player's PSC, due to the lack of any evident, relevant contractual arrangement between the team and the PSC. …

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