From:  Robert
Date:  Wed, 1 Sep 2010
Subject:  Avoiding a flat corporate tax rate of 35%

I am dealing with converting a Dentistry practice from an LLC to a corporation. The sole proprietor of the LLC also became the president of the corporation and the sole shareholder. As a result, the corporation is a personal holding corporation with a flat income tax rate of 35% instead of graduated tax rates for ordinary corporations. One solution to this problem would be to reduce the sole stockholder’s ownership of stock to 95% or less. Is there any other solution to this problem?

Answer

Date:  15 Oct 2010

Hello Robert,

The corporation is not a personal holding corporation, but a personal service corporation, defined at Internal Revenue Code Section 448(d)(2). The ownership requirement that you mention is defined at Treasury Regulations Section 1.448-1T(e)(5).

I am wondering why this decision to convert was made.

One alternative is to elect to be an S corporation, which actually has very similar results as being an LLC. An advantage of being an S corporation compared to being an LLC is computing retirement contributions is much simpler, since it’s based on W-2 income for an S corporation instead of self-employment income for an LLC.

The main way most personal service corporations deal with the problem is by paying out most of the income as wages by the end of the year. Retirement contributions can be made up to the extended due date of the corporate income tax returns.

Personal service corporations require careful monitoring and year-end tax planning.

(Note – Businesses of licensed professionals, such as health professionals, lawyers, CPAs, and architects aren’t permitted to be conducted as LLCs in California. Be sure to consult with an attorney about the rules in your state.)

Good luck!

Mike Gray

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