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Daisycpa
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Posted: 08 Jul 2009 at 09:38 \| IP Logged

The rule limiting the availability of passive activity losses and credits applies to

A. Partnerships

B. S. Corps

c. Personal service Corp.

D. Widely held C corp

The answer is C and I got the answer right but I don't understand why C is the correct answer. This is the explanation in the Wiley Book. Can someone explain what this means? Especially the first sentence. Thanks.

Application of the passive activity loss limitations to personal service corporations is intended to prevent taxpayers from sheltering personal service income by creating personal service corporations and acquiring passive activity losses at the corporate level. A personal service corporation is a corporation (1) whose principal activity is the performance of personal services and (2) such services are substantially performed by owner-employees. Since passive activity income, losses, and credits from partnerships and S corporations flow through to be reported on the tax returns of the owners of such entities, the passive activity limitations are applied at the partner and shareholder level, rather than to partnerships and S corporations themselves.

caixinran
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Posted: 08 Jul 2009 at 14:37 \| IP Logged

PALS:

In general, a taxpayer can only deduct passive activity
losses against passive activity income.

-------------- From IRS --------------

Passive income does not include portfolio income. This
includes interest, dividends, annuities, royalties not
derived in the ordinary course of business. Portfolio
income includes gains from the sale of assets that
produces these types of income or is held for investment.
Certain types of interest, called self-charged interest,
are passive.

The following income is not considered passive
income:

1) Overall gain from an interest in a publicly traded
partnership
2) State, Local, and foreign income tax refunds
3) Reimbursement from a casualty or theft loss included
in gross income, if the loss deduction was not a passive
activity deduction
4) Personal service income
5) Positive Section 481 accounting adjustments
6) Income from an oil and gas working interest if any
losses incurred after 1986 treated as nonpassive
Income from intangible property, if personal efforts
significantly contributed to the creation of the property
-------------- End of Reference --------------

1) S-corp and Partnership are Pass-through entities.
the passive activities rules applied to
Shareholder/Partner's individual tax returns Rather than
on entities themselves.

2) Personal Service Company (Type-C corp)generates
business revenue from the Personal Services, which are
active income. (Shareholder actively participate
on providing the personal service. such as tax,
consulting, law.. )

Please correct me if I am wrong!

Thanks

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LeadFoot
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Posted: 09 Jul 2009 at 11:54 \| IP Logged

Daisycpa wrote:

A closely held C corporation can offset passive activity losses against active income (but not portfolio income). If the PSC exception weren't there, a CPA can create a PSC, acquire passive activity losses, and offset the active business income. The PSC exception was put in place to prevent that kind of tax shelter.

Daisycpa
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Joined: 14 Aug 2006
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Posted: 09 Jul 2009 at 15:10 \| IP Logged

I think I was confusing PERSONAL SERVICE CORP for a Schedule C type business where the income/loss flows to the 1040.

But in this case a personal service corp is a C-corp right? So, because C-corps can offset passive activity losses with active income, therefore are limitations.

I think I get it now. Thank you for the clarification.

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