*1320 Held that the petitioner is not entitled to a greater allowance for earned income in the operation of a business school than 20 per cent of the net profit derived therefrom, the services of employees and the employment of capital having been material income-producing factors.
*384 These proceedings were consolidated for the redetermination of deficiencies of $167.98 and $185.41 in income taxes for the respective years 1925 and 1927. The issue is whether all or only 20 per cent of profits received by the petitioner in the operation of a commercial school should be treated as earned income.
FINDINGS OF FACT.
The petitioner, an individual residing in Brooklyn, New York, since 1912 has been in the business of conducting, as owner, the Alpha School, a commercial school located at 2 Sumner Avenue, Brooklyn, New York. The school has no branches and since 1913 has been *385 registered by the Board of Regents of the State of New York. In order to obtain such registration petitioner was required to satisfy the Board of Regents as to his*1321 character, education, and fitness to operate a registered business school.
The school occupied seven class rooms and two offices. The class rooms were equipped with about 400 desks, approximately 100 typewriters, calculating, mimeographing and multigraphing machines, and other appliances necessary to teach commercial subjects. The machines have to be replaced every three years. For the space used, petitioner paid a monthly rental of $575. He purchased typewriters on terms providing for the discharge of the price in installments over a period of three years.
The courses taught in the school were commercial subjects consisting of bookkeeping, stenography, typewriting, English, commercial arithmetic, commercial business ethics, business behaviour, penmanship and kindred subjects.
The school was open for instruction from 8.30 a.m. to 1 p.m., five days per week, and from 7.30 p.m. to 10 p.m., four days each week.
In 1925 and 1927 petitioner had about 400 students attending his day classes and about 200 his evening classes. The tuition fees were $10 per month for day students and $5 or $6 for evening students, payable in advance. The maximum period of grace allowed by petitioner*1322 for payment of tuition was one month.
The staff of the school consisted of about twelve teachers, graduates of institutions of higher education, two office girls, and three or four solicitors of enrollments. The instructors were qualified men and the most experienced petitioner could obtain. About five of them instructed both day and evening classes and the remainder day or evening classes.
The petitioner interviewed many of the students to determine a course of study suitable for them; arranged all the courses of study after consulting his teachers; selected text books to be used; wrote advertising copy; engaged teachers, supervised their work, and fixed their compensation; was qualified to teach all of the subjects given at the school and taught bookkeeping, commercial arithmetic, business ethics and behavior during about twenty-five of the approximately one hundred and forty hours of instruction given per week; handled general administrative matters for the school; decided upon disciplinary measures to be taken in cases referred to him by his teachers, and interviewed the parents of such students; conducted examinations on the subjects taught by him and gave final examinations*1323 in some of the other subjects; determined the fitness of students for graduation; endeavored to place his students in positions after graduation, and exercised immediate supervision over all of the activities of his school. *386 Every student was required to enroll for at least one of the subjects given by petitioner. In the taxable years petitioner was president, and as such, in charge of the Nest Corporation, a corporation engaged in the real estate and mortgage bond business. For this service he received a salary of $6,000 per year. He devoted his afternoons to this work and his mornings and evenings conducting the affairs of his school.
The tuition fees received by the Alpha School in 1925 and 1927 were, respectively, $63,848 and $56,752.25. For the respective years petitioner had income of $233.16 and $264.80 from the sale to students of text books, school pins, stationery, and supplies. These sales were made practically at cost as an accummodation to the students. The school had no other income. The amount expended for text books for the free use of the students was $3,117.73 in 1925, and $2,219.20 in 1927. Petitioner did not receive a commission from the publishers*1324 for handling or using the books.
In the taxable years petitioner had invested in furniture, fixtures, typewriters and other equipment in use at the school and expended for salaries and advertising in his conduct of the institution the following amounts:
| Item | 1925 | 1927 |
| Furniture, etc | $15,311.58 | $28,281.58 |
| Salaries | 30,832.81 | 29,008.76 |
| Advertising | 2,113.06 | 4,545.06 |
The cost of the equipment used in the school was paid for from current receipts. The increase in 1927 over 1925 was due to a change of equipment. The advertising was done in high school magazines and by distributing blotters and program cards in high schools. The school also advertised for positions for its graduates.
OPINION.
ARUNDELL: This proceeding involves section 209(a) of the Revenue Act of 1926, which, as far as material here, provides:
(1) The term "earned income" means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered * * *. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, a reasonable allowance as compensation*1325 for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income.
The statute quoted lays down two classifications in respect of the source of the income that is treated as earned. The first class is that in which the income is compensation for personal services *387 actually rendered. The second includes situations where, in addition to the personal services rendered, capital is a material income-producing factor. Petitioner contends that he comes within the first classification, whereas the respondent has determined that he comes under the second group. The descriptions of the two groups are contained in the same section of the statute, and the provisions regarding each group must be considered as being in pari materia. Neither one is to be regarded as an exception, but in each case it must be decided on the facts which classification is applicable.
In the present case the respondent has determined that the source of petitioner's income was the operation of a "trade or business in which both the personal services and capital are material*1326 income-producing factors." Under our procedure that determination is presumptively correct.
The evidence establishes that petitioner rendered personal services to the Alpha School and that at least a part of the income of the school was attributable to his services. We have no doubt that it may be possible to conduct a successful school entirely by means of personal service and without the use of capital. But in our opinion this is not such a case. Here we have a school for the conduct of which a building of substantial size is required, and in which there was used equipment valued at over $15,000 in 1925 and over $28,281.58 in 1927. These substantial investments can not easily be dismissed from view. The equipment owned by petitioner and used in the operation of the school included about 400 desks, 100 typewriters, a number of calculating machines, mimeographs, multigraphs, and other equipment necessary to teach commercial subjects, and one or two automobiles. Even the slightest knowledge of the operating methods of modern business or commercial schools makes it obvious that the possession of such equipment as petitioner had is more than a mere incident in the successful*1327 operation of the school. On the contrary, it is indispensable. The theory of bookkeeping might well be taught without extensive equipment, but modern schools realize that theory alone will not produce a practical bookkeeper and so they provide desks on which the student may spread his practice materials. It is equally plain that no amount of theory can produce a proficient typist or operator of machines used in modern business, but that machines for demonstration and practice are necessary. In ; affd., , one of the elements necessary for the taxpayer to establish was that capital was not a material factor in the production of income, which consisted largely of tuition fees. On this phase of the case the Circuit Court said:
* * * As to the tuition fees, it is perfectly plain that they were earned and produced by the use of a plant and equipment without which, no matter how *388 eloquent the teaching of the stockholding professors might have been, no matter how magnetic the influence and drawing capacity of the stockholders, no single student could have been drawn to the school, or*1328 if drawn, kept and instructed there.
In , in which the taxpayer was seeking classification as a personal service corporation, the court after referring to the taxpayer's investment in desks, typewriters and other teaching paraphernalia, said:
* * * That all this was capital can not be gainsaid, and that it was "income-producing" is as certain as the fact of its employment in the process of conferring education upon the students who were paying the price. The things represented by this capital investment constituted the "plant" which, directly operated by the teaching force, under the general direction of the management, conferred the education which produced the income.
The burden of proof in this proceeding is on the petitioner to show that capital was not a "material income-producing factor" within the meaning of that phrase as interpreted and applied by the courts in personal service corporation cases. The evidence here is mostly devoted to showing what petitioner's personal activities were in the operation of the school, and is insufficient to overcome the presumption that respondent was correct in classifying*1329 petitioner as one whose earned income is subject to the 20 per cent limitation.
Viewing the case from another angle, we are of the opinion that petitioner's income from the school does not come within the statutory definition of earned income as "amounts received for personal services actually rendered." Aside from the use of capital in the business, it is plain that the income was not due alone to petitioner's personal services. He employed about twelve teachers, to whom he paid annual salaries of approximately $30,000. Clearly, those instructors would not have been engaged if petitioner could have conducted the school on the same scale without them. Petitioner testified that the faculty was composed of the most experienced teachers he could get and that they were all graduates of institutions of higher learning. It is difficult to believe that teachers of the high caliber indicated by petitioner's testimony were merely incidental to the operation of the business. It is pointed out in , that teachers in a business school are in a very different class from messengers and others serving the principal owners in a personal capacity, *1330 and that it is mainly through the contact between teachers and students that tuition is earned.
On the evidence we see no error in respondent's limitation of earned income by the 20 per cent provision of the statute.
Decision will be entered under Rule 50.