T.C. Memo. 2007-140
UNITED STATES TAX COURT
CALPO HOM & DONG ARCHITECTS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4227-05. Filed June 4, 2007.
Richard Todd Luoma, for petitioner.
Christian A. Speck, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency of $7,506
in petitioner’s 2002 Federal corporate income tax. The issue for
decision is whether, during 2002, petitioner was a qualified
personal service corporation as defined by section 448(d)(2).1
1
Unless otherwise indicated, all section references are to
(continued...)
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulation of facts,
and the attached exhibits are incorporated herein by this
reference. At the time it filed its petition, petitioner’s
principal place of business was in Sacramento, California.
Petitioner, a corporation, offers architectural services and
other related services to its clients. In its promotional
materials, petitioner describes its services:
Calpo Hom & Dong Architects (CH&D) offers a full range
of architectural services, including master planning,
feasability studies, design, interior design, space
planning, facilities management, construction
administration, historic preservation and consulting
services.
* * * * * * *
Our widely diversified practice, encompassing large
scale planning projects to singular architectural
projects, affords us the latitude of a wide range of
knowledge from which we can draw our thoughts.
Our approach seeks a balanced weighing of elements that
make up architecture: design, the organization of
space and light, structure, systems, and materials.
To carry out these services, petitioner employs licensed
architects, unlicensed architects, and nonarchitects.
1
(...continued)
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
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During 2002, petitioner was owned 100 percent by architects
licensed to practice in the State of California. Petitioner
timely filed a Form 1120, U.S. Corporation Income Tax Return, for
2002, identifying its business activity as architecture.
Petitioner reported gross receipts of $2,728,291, cost of goods
sold of $850,006, total income of $1,857,382, total deductions of
$1,819,853, taxable income of $37,529, and total tax of $5,629.
To calculate the total tax, petitioner used the graduated tax
rates generally applicable to corporations, as provided in
section 11(b)(1).
On November 18, 2004, respondent issued petitioner a notice
of deficiency stating:
It is determined that for the taxable year shown below
[2002], CALPO HOM & DONG ARCHITECTS INC is a Personal
Service Corporation that is subject to a special flat
income tax rate of 35%.
The corporation is a qualified Personal Service
Corporation because substantially all of the
corporation’s activities involve the performance of
services in the fields of health, law, engineering,
architecture, accounting, actuarial science, the
performing arts, or consulting, and substantially all
of the stock of the corporation is held by employees
performing services for the corporation, retired
employees, employees’ or retired employees’ estates or
persons acquiring stock by reason of an employees’
death.
Using the flat 35-percent tax rate applicable to qualified
personal service corporations under section 11(b)(2), respondent
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determined a corrected tax liability of $13,135 and a deficiency
of $7,506 in petitioner’s 2002 Federal corporate income tax.
In response to the notice of deficiency, petitioner timely
filed a petition with this Court.
OPINION
I. Applicable Code Sections and Regulations
Section 11(a) imposes a tax on the taxable income of every
corporation. Section 11(b)(1) provides graduated tax rates
generally applicable to corporations. However, section 11(b)(2)
provides: “Notwithstanding paragraph (1), the amount of the tax
imposed by subsection (a) on the taxable income of a qualified
personal service corporation (as defined in section 448(d)(2))
shall be equal to 35 percent of the taxable income.”
A corporation is a qualified personal service corporation if
it meets both the “function test” and the “ownership test” of
section 448(d)(2). See sec. 1.448-1T(e)(3), Temporary Income Tax
Regs., 52 Fed. Reg. 22768 (June 16, 1987). Under the function
test, “substantially all of the activities [of the corporation
must] * * * involve the performance of services in the fields of
health, law, engineering, architecture, accounting, actuarial
science, performing arts, or consulting”. Sec. 448(d)(2)(A)
(emphasis added). Section 1.448-1T(e)(4)(i), Temporary Income
Tax Regs., supra, further describes the function test:
A corporation meets the function test if substantially
all the corporation’s activities for a taxable year
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involve the performance of services in one or more of
the following fields--
(A) Health,
(B) Law,
(C) Engineering (including surveying and mapping),
(D) Architecture,
(E) Accounting,
(F) Actuarial science,
(G) Performing arts, or
(H) Consulting.
Substantially all of the activities of a corporation
are involved in the performance of services in any
field described in the preceding sentence (a qualifying
field), only if 95 percent or more of the time spent by
employees of the corporation * * * is devoted to the
performance of services in a qualifying field. * * *
[Emphasis added.]
As relevant to this case, a corporation meets the ownership test
if substantially all of the corporation’s stock (by value) is
held directly (or indirectly) by employees performing services
for the corporation in connection with activities involving a
qualifying field. Sec. 448(d)(2)(B); see also sec. 1.448-
1T(e)(5), Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June
16, 1987).
II. The Parties’ Positions
Petitioner asserts that, during 2002, approximately 70
percent of its activities involved the performance of services in
the qualifying field of architecture. Petitioner asserts that
the remaining 30 percent of its activities involved the
performance of nonarchitectural services. Petitioner concludes
that, because less than substantially all (less than 95 percent)
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of its activities were devoted to the performance of
architectural services, it was not a qualified personal service
corporation.
Respondent argues that, during 2002, petitioner was a
qualified personal service corporation. Respondent asserts that
petitioner met the ownership test because petitioner was owned
100 percent by employees who performed architectural services.
Respondent also asserts that petitioner met the function test,
and advances two alternative arguments: (1) Petitioner’s
classification of architectural and nonarchitectural services is
incorrect, many of the “nonarchitectural” services are actually
architectural services, and more than 95 percent of petitioner’s
activities involved the performance of services in the qualifying
field of architecture; or (2) even if petitioner’s classification
is correct, the nonarchitectural services are in the qualifying
field of consulting, and more than 95 percent of petitioner’s
activities involved the performance of services in the qualifying
fields of architecture and consulting.
Petitioner concedes that it meets the ownership test because
it was owned 100 percent by architects.2 Petitioner does not
2
Apparently, petitioner concedes that it meets the
ownership test only if the Court concludes that only one
qualifying field can be considered in applying the function test.
It is unclear why petitioner limits its concession in this
manner. Nevertheless, because we consider only one of the
qualifying fields in determining petitioner failed to meet its
(continued...)
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dispute that its “nonarchitectural” services could be classified
as consulting services for purposes of section 448(d)(2)(A).
However, petitioner argues that, when drafting section 448(d)(2),
Congress intended to limit the definition of a qualified personal
service corporation to a corporation where substantially all
activities were performed in only one of the qualifying fields.
Petitioner does not cite any legislative history to support its
argument. Instead, petitioner interprets the use of “or”, which
separates the final two qualifying fields in section
448(d)(2)(A), to mean that only one qualifying field can be
considered. Petitioner argues that, to the extent the temporary
regulations allow the qualifying fields to be combined (“A
corporation meets the function test if substantially all the
corporation’s activities * * * involve the performance of
services in one or more of the following fields” (emphasis
added)), the regulations are invalid.
We need not address whether petitioner’s classification of
architectural and nonarchitectural services is correct,3 nor do
2
(...continued)
burden of proof, see infra, the condition on petitioner’s
concession has been met.
3
Petitioner’s classification of services is questionable
for many reasons, not the least of which is that some of the
services petitioner now classifies as nonarchitectural services
were identified as architectural services in its promotional
materials. Any reference below to architectural services and
nonarchitectural services does not constitute a finding by this
(continued...)
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we need to discuss the validity of section 1.448-1T(e)(4),
Temporary Income Tax Regs., supra. Assuming arguendo that
petitioner’s classification of services is correct, and that for
a corporation to be a qualified personal service corporation,
substantially all of its activities must involve the performance
of services in only one of the qualifying fields, conclusions we
explicitly decline to draw, petitioner would still bear the
burden of proving that less than substantially all of its
activities involved the performance of architectural services.4
See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
As described below, petitioner failed to meet its burden.
III. Analysis
To establish that less than substantially all of its
activities involved the performance of architectural services,
petitioner relies exclusively on monthly revenue summaries and a
2002 annual revenue summary (the revenue summaries). The revenue
summaries purport to break down revenue petitioner received by
specific types of services, with each service classified as
3
(...continued)
Court. Instead, such references are used for the purpose of
clarity in demonstrating that, even if petitioner’s
classification were accepted, petitioner would still fail to meet
its burden of proof.
4
Under sec. 7491(a), the burden of proof may shift to the
Commissioner in certain situations. Petitioner does not argue
that the burden of proof shifts to respondent.
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architectural or nonarchitectural.5 Petitioner concludes on the
basis of the revenue summaries that of its 2002 revenue totaling
$2,442,122,6 $1,710,502 was received for architectural services
and $731,620 was received for nonarchitectural services.
The fatal flaw in petitioner’s approach is that the revenue
summaries measure the wrong data. Under the function test of
section 448(d)(2), “substantially all of the activities * * *
[must] involve the performance of services in the fields of * * *
architecture”. (Emphasis added.) Section 1.448-1T(e)(4)(i),
Temporary Income Tax Regs., supra, states: “Substantially all of
the activities of a corporation are involved in the performance
of services in any field * * * only if 95 percent or more of the
time spent by employees of the corporation * * * is devoted to
the performance of services in a qualifying field.” (Emphasis
added.) In other words, the appropriate inquiry is whether
petitioner’s employees devoted substantially all of their time to
the performance of architectural services. The revenue summaries
5
Petitioner’s architectural services included schematic
design, design development, construction documents and bid
negotiations, construction document support, and specialized
architectural services; petitioner’s nonarchitectural services
included space planning, space planning support, price planning,
interior design, construction administration, specialized
services, and outside consulting.
6
We note that petitioner’s revenue summaries indicate
total 2002 revenue of $2,442,122, while its 2002 tax return
indicates gross receipts of $2,728,291. Petitioner does not
explain this discrepancy.
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measure only the revenue received in 2002; they do not measure
the amount of time petitioner’s employees devoted to the
performance of architectural services.
Petitioner apparently recognized this problem and attempted
to establish a link between the revenue received and the time
spent on the performance of architectural services. One of
petitioner’s architect-owners, Alan Hom (Mr. Hom), testified that
the average hourly billing rate for architectural services was
$100 and the average hourly billing rate for nonarchitectural
services was between $85 and $90. Petitioner used the revenue
summaries and Mr. Hom’s testimony to extrapolate the approximate
number of hours worked by petitioner’s employees in the
performance of architectural and nonarchitectural services.
Petitioner requested that the Court find as fact:
For 2002, the number of hours spent on architectural
services based on revenue for such services and the
average hourly rate of $100 was 17,105. * * * For
2002, the number of hours spent on non-architectural
services based on revenue for such services and the
average hourly rate of $85 to $90 was 8,607 (at $85 per
hour) or 8,129 (at $90 per hour). * * *
For 2002, based on hours spent on architectural
services versus all time spent on all services,
petitioner’s architectural services represented 66.52%
(when the average rate for non-architectural services
is calculated at $85 per hour) and 67.78% (when the
average rate for non-architectural services is
calculated at $90 per hour).
There are several problems with petitioner’s approach.
First, other than Mr. Hom’s testimony, petitioner presented no
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evidence to establish average hourly rates. Mr. Hom did not
refer to any specific documents to support his testimony, and he
appeared to be offering only rough estimates. We give little
weight to Mr. Hom’s unsupported testimony.
Even if Mr. Hom’s estimates were reliable, the estimates
appear to be applicable only to projects where petitioner billed
its clients at an hourly rate. Petitioner’s contracts
demonstrate a variety of billing methods, including fixed fees,
hourly fee agreements, and hourly fee agreements with maximum
total fees based on the usable square footage of the project.
Mr. Hom testified that only 40 to 50 percent of the contracts
billed for services at an hourly rate. We do not believe that
petitioner’s approach provides an accurate measure of the time
petitioner’s employees devoted to the performance of
architectural services, particularly considering petitioner
billed no more than half of its clients at an hourly rate.
Even if Mr. Hom’s estimates could be used to determine time
spent, regardless of the billing method, the revenue summaries
still would not provide an accurate measure of the time spent by
petitioner’s employees during 2002. For example, petitioner’s
January 2002 revenue summary lists revenue from 28 projects.7 Of
7
The following project numbers appear on petitioner’s
January 2002 revenue summary: 00137.00; 00184.00; 00203.00;
00209.00; 00223.00; 00268.00; 01014.00; 01049.00; 01070.00;
01089.03; 01089.04; 01097.00; 01133.00; 01134.00; 01147.00;
(continued...)
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the 28 projects, 18 projects do not appear on any of petitioner’s
employees’ time sheets for January 2002.8
The mismatching of revenue and time spent is even clearer
when comparing individual employees’ time sheets with the monthly
revenue summaries. According to Frank Bravo’s (Mr. Bravo’s) time
sheets, Mr. Bravo worked on 10 projects during January 2002.
Between February and October 2002, petitioner received revenue
from seven of Mr. Bravo’s January projects, but it received no
revenue during 2002 from three of the projects. According to
Karl Chan’s (Mr. Chan’s) time sheets, Mr. Chan worked on 19
projects during January 2002. Between March and October 2002,
petitioner received revenue from 14 of Mr. Chan’s January
projects, but it received no revenue during 2002 from 5 of the
projects. According to Mr. Hom’s time sheets, Mr. Hom worked on
16 projects during January 2002. Between March and August 2002,
petitioner received revenue from seven of Mr. Hom’s January
projects, but it received no revenue during 2002 from nine of the
projects. This pattern is not limited to these employees, nor is
7
(...continued)
01154.00; 01157.00; 01167.00; 01193.00; 01204.00; 01218.00;
01218.01; 01221.00; 01247.00; 01253.00; 01259.00; 01264.00;
01272.00.
8
Of the project numbers appearing on petitioner’s January
2002 revenue summary, only the following 10 project numbers
appear on petitioner’s employees’ time sheets for January 2002:
00184.00; 00203.00; 00223.00; 00268.00; 01014.00; 01133.00;
01221.00; 01247.00; 01253.00; 01264.00.
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it limited to services performed in January 2002. These are only
three examples that reflect a pattern of mismatching of revenue
and time spent by nearly all of petitioner’s employees during all
months of 2002. The conclusion is inescapable--petitioner’s 2002
revenues do not measure the time spent by petitioner’s employees
during 2002. Some of petitioner’s 2002 revenue was received for
work done outside of 2002, and petitioner received no revenue
during 2002 for some of the work done by its employees during
2002.
Finally, petitioner’s 2002 revenue from nonarchitectural
services included revenue from “outside consulting”. Mr. Hom
testified that outside consulting included “mechanical,
electrical engineers, plumbing engineers, that basically since we
don’t have those engineers in-house, we consult out for them.”
In other words, petitioner received revenue during 2002 for work
done by people other than petitioner’s employees. By including
revenue from outside consulting, petitioner measured time spent
by nonemployees, making petitioner’s estimation of time spent by
its employees even more inaccurate.
For the above reasons, we find that petitioner failed to
prove that less than substantially all of its activities were
devoted to the performance of services in the qualifying field of
architecture. We sustain respondent’s determination that, during
2002, petitioner was a qualified personal service corporation
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under section 448(d)(2), thus subject to a flat 35-percent tax
rate under section 11(b)(2).
In reaching our holdings, we have considered all arguments
and contentions made, and, to the extent not mentioned above, we
conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be
entered for respondent.