T.C. Memo. 2008-140
UNITED STATES TAX COURT
GRUTMAN-MAZLER ENGINEERING INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14843-06. Filed May 21, 2008.
Gregory Mazler (an officer), for petitioner.
Jonathan Sloat, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined a $1,529.45 deficiency
in petitioner’s Federal income tax for the taxable year ended
October 31, 2004 (the year at issue).1 The sole issue for
1
Respondent also determined that petitioner was liable for
additions to tax under sec. 6651(a)(1) and (2) of $891.49 and
$396.22, respectively. Respondent concedes these additions to
tax.
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decision is whether petitioner is a qualified personal service
corporation subject to a special flat 35-percent income tax rate
under section 11(b)(2) rather than the graduated income tax rates
for corporations under section 11(b)(1).2 We hold that
petitioner is a qualified personal service corporation.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated by this reference. Petitioner’s principal place of
business was California at the time it filed the petition.
Petitioner is an engineering company incorporated in
California in 1990. Petitioner provides engineering services in
the Los Angeles area, including planning subdivisions.
Specifically, petitioner prepares grading plans, designs plans
for storm drains, sewers, streets, water lines and utilities, as
well as prepares tract maps for subdivisions.
Petitioner had two owners during the year at issue. Ruvin
Grutman (Mr. Grutman), a registered civil engineer and licensed
land surveyor, owned 60 percent of the value of petitioner’s
stock, while Gregory Mazler (Mr. Mazler) owned the remaining 40
percent. Mr. Mazler is not a registered civil engineer although
he has a degree in engineering. Mr. Grutman performed
engineering services for petitioner and also oversaw all of
2
All section references are to the Internal Revenue Code in
effect for the year at issue, unless otherwise indicated.
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petitioner’s activities during the year at issue. Petitioner had
28 employees in total, including Mr. Grutman and Mr. Mazler.
Petitioner had a “Planning Department” that consisted of
three employees.3 The employees in the Planning Department were
Mr. Mazler, Veronica Granovsky (Ms. Granovsky) and Eugene
Steinberg (Mr. Steinberg). Mr. Mazler’s duties included
submitting tentative tract maps and grading plans to local
governments for approval and also supervising the activities of
Ms. Granovsky and Mr. Steinberg. Mr. Mazler performed some
engineering services. These services included presenting maps to
planning departments in public hearings, but these services
constituted only a small portion of his workload. Ms.
Granovsky’s and Mr. Steinberg’s duties included assisting
individuals performing petitioner’s engineering, land surveying,
and mapping activities. Ms. Granovsky and Mr. Steinberg also
submitted designs, plans, specifications and engineering reports
to local governments. Ms. Granovsky also coordinated the work of
professional, technical or special consultants. Mr. Steinberg
was identified in petitioner’s organizational charts as Ms.
Granovsky’s assistant. Both Ms. Granovsky and Mr. Steinberg also
3
The organizational chart submitted to the Court as an
exhibit refers to this department as the Planning Department.
Mr. Grutman referred to this department as the processing
department in his testimony. We shall refer to this department
as the Planning Department.
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spent a small amount of time processing bonds for the engineering
projects.
Petitioner’s financial accounts did not account separately
for the Planning Department or for income from processing plans
through local governments. Petitioner’s ledgers differentiated
income from civil engineering, construction management, land
surveying, and rental income but did not account separately for
income of the Planning Department.
Petitioner reported on its tax return for the year at issue
that it was engaged in engineering. It reported that its taxable
income was subject to the graduated income tax rates for
corporations under section 11(b)(1). Respondent issued
petitioner a deficiency notice in which he determined that
petitioner was a qualified personal service corporation subject
to the flat 35-percent tax rate under section 11(b)(2).4 The
deficiency represents the increase in petitioner’s Federal income
tax that results from applying the flat 35-percent tax rate to
the amounts of taxable income shown on the return for the year at
issue. Petitioner timely filed a petition.
OPINION
We are asked to decide whether petitioner is a qualified
personal service corporation taxed at a flat 35-percent rate
4
The flat 35-percent tax rate set forth in sec. 11(b)(2)
equals the highest marginal corporate tax rate set forth in sec.
11(b)(1) for the year at issue.
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under section 11(b)(2) rather than the graduated rates for
corporations under section 11(b)(1). A qualified personal
service corporation is any corporation that satisfies a function
test and an ownership test. Sec. 448(d)(2)(A) and (B)(i); W.W.
Eure, M.D., Inc. v. Commissioner, T.C. Memo. 2007-124; sec.
1.448-1T(e)(3), (4), and (5), Temporary Income Tax Regs., 52 Fed.
Reg. 22768 (June 16, 1987), as amended by T.D. 8329, 56 Fed. Reg.
485 (Jan. 7, 1991), and T.D. 8514, 58 Fed. Reg. 68299 (Dec. 27,
1993). Petitioner argues that it is not a qualified personal
service corporation because it does not meet either the function
test or the ownership test. We disagree and find that petitioner
satisfies both tests and is therefore a qualified personal
service corporation. We shall consider each test in turn.5
The Ownership Test
The ownership test is met when 95 percent or more of the
corporation’s stock is held by employees performing services for
the corporation in connection with activities involving a
qualifying field. Sec. 448(d)(2); sec. 1.448-1T(e)(5)(i),
Temporary Income Tax Regs., supra. The qualifying field in this
case is engineering (including surveying and mapping). See sec.
1.448-1T(e)(4)(i)(C), Temporary Income Tax Regs., supra.
5
The Court ruled at trial that petitioner had the burden of
proof. On brief, petitioner asks the Court to reconsider its
ruling. The Court declines to reconsider its ruling. The burden
of proof remains with petitioner.
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Mr. Grutman owned 60 percent of petitioner’s stock and Mr.
Mazler owned 40 percent of petitioner’s stock during the year at
issue. Mr. Grutman was a licensed engineer and land surveyor who
performed engineering services for petitioner. Mr. Mazler had an
engineering degree and performed at least some engineering
services during the year at issue although it was just a small
portion of his workload. Petitioner argues, however, that Mr.
Mazler’s ownership fails to meet the ownership test because his
activities fit solely in the Planning Department, not in the
general engineering field. We disagree.
First, section 448 requires only that the employees owning
the stock perform services in connection with the qualifying
field activities. Sec. 448(d)(2). There is no requirement in
the ownership test that the stockholder-employees perform a
certain percentage of their services, or substantially all of
their services, in the qualifying field or in connection with the
qualifying field. Mr. Mazler’s performance of some engineering
services during the year at issue therefore means that 100
percent of the stock was held by employees who performed
engineering services. See id. Further, as we shall more fully
explain below, the activities of the Planning Department
constitute engineering activities or activities incident to
engineering activities. Accordingly, Mr. Mazler’s activities in
the Planning Department are also in a qualifying field. We
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conclude that petitioner meets the ownership test because both
owners of petitioner’s stock performed services in the
engineering field.
The Function Test
We shall now turn to the function test. To meet the
function test, 95 percent or more of employees’ time must be
spent providing services in one of several enumerated fields,
including engineering. Sec. 448(d)(2); sec. 1.448-1T(e)(4)(i),
Temporary Income Tax Regs., supra. The performance of any
activity incident to the actual performance of services in a
qualifying field is considered the performance of services in
that field under the function test. Sec. 1.448-1T(e)(4)(i),
Temporary Income Tax Regs., supra. Activities incident to the
performance of services in a qualifying field include the
supervision of employees engaged in directly providing services
to clients and performing administrative and support services
incident to such activities. Id.
Petitioner argues that it does not meet the function test
because the activities of the Planning Department do not
constitute engineering. Again, we disagree.
Engineering is not defined in section 448 or the
corresponding regulations. We may examine state law to determine
whether an activity is within a qualifying field. See Rainbow
Tax Serv., Inc. v. Commissioner, 128 T.C. 42, 47 (2007).
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California law defines civil engineering as the following studies
or activities in connection with fixed works:
(a) The economics of, the use and design of,
materials of construction and the determination of
their physical qualities.
(b) The supervision of the construction of engineering
structures.
(c) The investigation of the laws, phenomena and forces
of nature.
(d) Appraisals or valuations.
(e) The preparation or submission of designs, plans and
specifications and engineering reports.
(f) Coordination of the work of professional,
technical, or special consultants.
(g) Creation, preparation, or modification of
electronic or computerized data in the performance of the
activities described in subdivisions (a) through (f).
Cal. Bus. & Prof. Code sec. 6731 (West 1995) (emphasis added).
Accordingly, under California law, preparing and submitting
designs, plans and specifications, and engineering reports and
coordinating the work of consultants are civil engineering
activities. Id. Activities incident to civil engineering
activities are also qualifying activities. Sec. 1.448-
1T(e)(4)(i), Temporary Income Tax Regs., supra. Accordingly,
activities that are incident to preparing and submitting designs,
plans and specifications and engineering reports also constitute
qualifying activities. Id.
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Petitioner’s Planning Department undertook activities such
as submitting designs, plans, tentative tract maps, grading
plans, and engineering reports to local governments and
coordinating other professionals. Each of these activities
constitutes civil engineering under California law and is
therefore a qualifying activity. Petitioner’s Planning
Department also assisted and supported engineers in other
departments. This activity is incident to civil engineering
activities and is also therefore a qualifying activity.
Petitioner argues that civil engineering may only be
performed by individuals with a civil engineering license and
none of the Planning Department’s employees had a license.
Petitioner’s argument is misplaced. Mr. Grutman, a registered
civil engineer, oversaw all of petitioner’s operations. A
subordinate to a civil engineer is exempt from licensure if he or
she performs only in that capacity. Cal. Bus & Prof. Code Sec.
6740 (West Supp. 2008). The Planning Department employees’ lack
of engineering licenses thus does not preclude them from
performing qualifying activities. See also Rainbow Tax Serv.,
Inc. v. Commissioner, supra at 46-47 (rejecting argument that
accountants cannot perform accounting services where they lack
CPA licenses).
Moreover, even if we accepted petitioner’s argument that all
the activities performed by the Planning Department were not
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qualifying activities, petitioner has failed to prove that such
activities exceeded 5 percent of all employees’ time. Petitioner
introduced incomplete time records for its employees. Petitioner
produced timesheets for Ms. Granovsky that covered the entire
taxable year but produced timesheets for Mr. Steinberg only for
July 15, 2004, through the end of the taxable year, less than 4
months. Petitioner produced no timesheets for Mr. Mazler and no
timesheets for the 25 other employees who were not in the
Planning Department. The lack of evidence makes it impossible to
determine that the activities of the Planning Department
constituted more than 5 percent of all the activities of
petitioner. Petitioner’s failure to produce the time records of
the other employees leads us to infer that if such evidence were
introduced, it would be unfavorable to petitioner. See Wichita
Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946), affd.
162 F.2d 513 (10th Cir. 1947).
Petitioner urges us to find that the Planning Department
constituted more than 5 percent of the employees by pointing out
that dividing three employees by the 28 total employees yields a
number larger than 5 percent. We can do the math, but we are
unconvinced of the meaning of the result. Petitioner’s argument
assumes that the employees in the Planning Department performed
no services in qualifying fields, which, as discussed above, is
incorrect. Petitioner’s argument also assumes that each employee
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performed exactly the same amount of services for petitioner.
There is no evidence in the record to support this assumption.
Petitioner relies on Alron Engg. & Testing Corp. v.
Commissioner, T.C. Memo. 2000-335, to support its argument that
it is not a qualified personal service corporation. Alron Engg.
is distinguishable on many grounds. The company in Alron Engg.
performed both engineering services and geotechnical testing
services. Id. We found in Alron Engg., after examining
Wisconsin law, that geotechnical testing did not constitute
engineering. Id. Here, on the other hand, the activities
performed by the Planning Department constitute civil engineering
under California law and are therefore qualifying activities.
Further relying on Alron Engg., petitioner argues that
petitioner could have separately negotiated to provide only the
services of the Planning Department to customers without any
corresponding engineering services. This argument is of no
moment. The activities performed by the Planning Department
constitute civil engineering under State law, regardless of
whether they were provided in separate contracts. Also, unlike
the taxpayer in Alron Engg., petitioner did not separately
account for the activities of the Planning Department in its
books and records.
We conclude that petitioner satisfies the function test by
having 95 percent or more of its employees’ time spent providing
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engineering services or services incidental to engineering
services. We also conclude that petitioner satisfies the
ownership test because all of its stock was held by employees
performing services in connection with a qualifying field.
Accordingly, petitioner is a qualified personal service
corporation subject to the flat tax rate under section 11(b)(2)
for the year at issue.
To reflect the foregoing,
Decision will be entered
for respondent.