J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

10.15 Personal Service and Closely Held Corporations

To prevent avoidance of the passive activity rules through use of corporations, the law imposes restrictions on income and loss offsets in closely held C corporations and personal service corporations.

Unless the material participation tests discussed in this section are met, the activities of a personal service corporation or a closely held corporation are considered passive activities, subject to the restrictions on loss deductions and tax credits. For purposes of these passive activity rules, a closely held C corporation is a corporation in which more than 50% in value of the stock is owned by five or fewer persons during the last half of the tax year.

A personal service corporation is a C corporation the principal activity of which is the performance of personal services by the employee-owners. Personal services are services in the fields of health, law, engineering, architecture, accounting, actuarial sciences, performing arts, or consulting. An employee-owner is any employee who on any day in the tax year owns any stock in the corporation. If an individual owns any stock in a corporation which in turn owns stock in another corporation, the individual is deemed to own a proportionate part of the stock in the other corporation. Further, more than 10% of the corporation’s stock by value must be owned by owner-employees for the corporation to be a personal service corporation.

Form 8810 must be used.

Personal service corporations ...