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Publication 542


Attention: This publication will no longer be revised on an annual basis. To find changes that may affect current year returns, see What's New in your income tax return instructions; Publication 553; and What's Hot In Tax Forms, Pubs, and Other Tax Products at To comment on this revision process, see Comments and suggestions on page 2.


Photographs of missing children.

The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.


This publication discusses the general tax laws that apply to ordinary domestic corporations. It explains the tax law in plain language so it will be easier to understand. However, the information given does not cover every situation and is not intended to replace the law or change its meaning.

Comments and suggestions.

We welcome your comments about this publication and your suggestions for future editions.
You can write to us at the following address:

Internal Revenue Service  
Business Forms and Publications Branch  
1111 Constitution Ave. NW, IR-6406  
Washington, DC 20224

We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.
You can email us at * (The asterisk must be included in the address.) Put "Publications Comment" on the subject line. Although we cannot respond individually to each comment, we do appreciate your feedback and will consider your comments as we revise our tax products.

Tax questions.

If you have a tax question, visit or call 1-800-829-1040. We cannot answer tax questions at either of the addresses listed above.

Ordering forms and publications.

Visit to download forms and publications, call 1-800-829-3676, or write to the National Distribution Center at the address shown under How to Get Tax Help on page 22 of this publication.


See page 24 for a list of forms that a corporation may need to file in addition to the forms discussed throughout this publication.


Useful items

You may want to see:

 535 Business Expenses
 538 Accounting Periods and Methods
 544 Sales and Other Dispositions of Assets
 925 Passive Activity and At-Risk Rules

Businesses Taxed as Corporations

The rules you must use to determine whether a business is taxed as a corporation changed for businesses formed after 1996.

Business formed before 1997.

A business formed before 1997 and taxed as a corporation under the old rules will generally continue to be taxed as a corporation.

Business formed after 1996.

The following businesses formed after 1996 are taxed as corporations.

S corporations.

Some corporations may meet the qualifications for electing to be S corporations. For information on S corporations, see the instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.

Personal service corporations.

A corporation is a personal service corporation if it meets all of the following requirements.
  1. Its principal activity during the "testing period" is performing personal services (defined later). Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of:
    1. The last day of its tax year, or
    2. The last day of the calendar year in which its tax year begins.
  2. Its employee-owners substantially perform the services in (1). This requirement is met if more than 20% of the corporation's compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.
  3. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period.
Personal services.
Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.
A person is an employee-owner of a personal service corporation if both of the following apply.
  1. He or she is an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if he or she is an independent contractor for other purposes) on any day of the testing period.
  2. He or she owns any stock in the corporation at any time during the testing period.
Other rules.
For other rules that apply to personal service corporations see Accounting Periods, later.

Closely held corporations.

A corporation is closely held if all of the following apply.
  1. It is not a personal service corporation.
  2. At any time during the last half of the tax year, more than 50% of the value of its outstanding stock is, directly or indirectly, owned by or for five or fewer individuals. "Individual" includes certain trusts and private foundations.
Other rules.
For the at-risk rules that apply to closely held corporations, see At-Risk Limitations, later.