128 T.C. No. 5
UNITED STATES TAX COURT
RAINBOW TAX SERVICE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7738-05. Filed March 8, 2007.
Petitioner employed individuals to provide tax return preparation and bookkeeping services. Petitioner calculated its tax liability for petitioner’s tax years ending June 30, 2002 and 2003, using the graduated corporate income tax rates set forth in sec. 11(b)(1), I.R.C.
Held: Petitioner’s tax return preparation and bookkeeping services constitute accounting services for purposes of sec. 448(d)(2), I.R.C., and petitioner is therefore subject to the sec. 11(b)(2), I.R.C., flat 35-percent tax rate applicable to qualified personal service corporations.
Donna Joyner-Rodgers (an officer), for petitioner.
Derek W. Kaczmarek, for respondent. - 2 - SWIFT, Judge: Respondent determined deficiencies of $11,903
and $5,003, respectively, in petitioner’s Federal income taxes
for petitioner’s tax years ending June 30, 2002 and 2003.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
The issue for decision is whether petitioner’s tax return
preparation and bookkeeping services are to be treated as
accounting services. If so, petitioner will be treated as a
qualified personal service corporation under section 448(d)(2)
and will be subject to the flat 35-percent tax rate set forth in
section 11(b)(2).
FINDINGS OF FACT
Most of the facts have been stipulated and are so found.
At the time the petition was filed, petitioner’s principal
place of business was located in Las Vegas, Nevada.
In 1978, Steve Rodgers (Rodgers) incorporated petitioner as
a Nevada corporation, and until his death in 2002 Rodgers owned
all of petitioner’s stock. Petitioner’s business consisted of
providing tax return preparation and bookkeeping services, which
services Rodgers and other individuals provided as petitioner’s
employees.
Over the years, Rodgers, on petitioner’s behalf, increased
the number of petitioner’s clients and the number of employees to
perform for petitioner’s clients tax return preparation and - 3 - bookkeeping services, and eventually petitioner opened two
additional offices in the Las Vegas area.
After Rodgers’ death in 2002, Rodgers’ wife, Donna Joyner-
Rodgers (Joyner-Rodgers), succeeded Rodgers as petitioner’s
president and assumed management of petitioner and of
petitioner’s three offices. Also, after Rodgers’ death
petitioner’s stock was owned by Rodgers’ estate, and then in
2004, petitioner’s stock was transferred from Rodgers’ estate to
Joyner-Rodgers.
In addition to her administrative and managerial
responsibilities relating to petitioner, Joyner-Rodgers, as an
employee of petitioner, also provides to petitioner’s clients tax
return preparation services.
During the years in issue, petitioner’s tax return
preparation services generally consisted of the preparation of
clients’ Federal and State individual, corporate, partnership,
gift, and estate tax returns. Petitioner’s bookkeeping services
generally consisted of the preparation, from client records, of
profit and loss statements and various other reports and forms
relating to client Federal payroll taxes, State unemployment
taxes, and sales taxes.
Petitioner is not a public accounting firm, and petitioner’s
employees do not perform services that require petitioner’s
employees to obtain Certified Public Accountant (C.P.A.) - 4 - licenses. Neither Rodgers nor Joyner-Rodgers ever held C.P.A.
licenses.
For the years in issue, petitioner’s employees (including
Rodgers and Joyner-Rodgers) spent all of their work-related time
performing for petitioner’s clients tax return preparation and
bookkeeping services and related administrative and support
services.
On each of petitioner’s timely filed corporate Federal
income tax returns, petitioner’s income tax liability was
calculated using the section 11(b)(1) graduated income tax rates
applicable to corporations.
On April 14, 2005, respondent issued to petitioner a notice
of deficiency in which respondent determined that petitioner’s
tax return preparation and bookkeeping services constituted
accounting services and therefore that petitioner, for the years
in issue, should be treated as a qualified personal service
corporation subject to the flat 35-percent tax rate set forth in
section 11(b)(2). The amounts of the deficiencies herein
represent the increase in petitioner’s Federal income taxes as a
result of applying the flat 35-percent tax rate.1
1 For the years in issue, 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). - 5 - OPINION
In general, for Federal income tax purposes, corporations
are taxed at graduated income tax rates. Sec. 11(b)(1).
So-called qualified personal service corporations as defined in
section 448(d)(2), however, are taxed at a flat 35-percent income
tax rate. Sec. 11(b)(2).
A corporation is to be treated as a qualified personal
service corporation (1) if substantially all of the corporation’s
activities involve the performance of services in the fields of
“health, law, engineering, architecture, accounting, actuarial
science, performing arts, or consulting” (hereafter covered
services), sec. 448(d)(2)(A); sec. 1.448-1T(e)(4)(i), Temporary
Income Tax Regs., 52 Fed. Reg. 22768 (June 16, 1987) (the
“function test”); and (2) if 95 percent of the corporation’s
stock is owned by, among others, individual employees performing
covered services for the corporation (or by the estate of a prior
employee of the corporation who performed covered services for
the corporation), sec. 448(d)(2)(B); sec. 1.448-1T(e)(5)(i),
Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987)
(the “ownership test”).
Substantially all of a corporation’s activities will be
treated as covered services only if in the aggregate the
corporation’s employees spend 95 percent or more of their time in - 6 - performing covered services. Sec. 1.448-1T(e)(4)(i), Temporary
Income Tax Regs., supra. In calculating the amount of employee
time spent performing covered services, administrative and
support services incident to covered services are treated as
covered services. Id.
Section 448(d)(2), the regulations thereunder, and court
opinions generally do not define accounting services.2 However,
in section 1.448-1T(e)(5)(vii), Example 1(i), Temporary Income
Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987), the preparation of
tax returns and audit and financial statements are treated as
accounting services:
X, a corporation, is engaged in the business of providing accounting services to its clients. These services consist of the preparation of audit and financial statements and the preparation of tax returns. For purposes of section 448, such services consist of the performance of services in the field of accounting. * * *
Petitioner concedes that, if tax return preparation and
bookkeeping services constitute accounting services, by virtue of
Rodgers’ and Rodgers’ estate’s ownership of petitioner’s stock,
the above ownership test has been satisfied.
2 In Ron Lykins, Inc. v. Commissioner, T.C. Memo.
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128 T.C. No. 5
UNITED STATES TAX COURT
RAINBOW TAX SERVICE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7738-05. Filed March 8, 2007.
Petitioner employed individuals to provide tax return preparation and bookkeeping services. Petitioner calculated its tax liability for petitioner’s tax years ending June 30, 2002 and 2003, using the graduated corporate income tax rates set forth in sec. 11(b)(1), I.R.C.
Held: Petitioner’s tax return preparation and bookkeeping services constitute accounting services for purposes of sec. 448(d)(2), I.R.C., and petitioner is therefore subject to the sec. 11(b)(2), I.R.C., flat 35-percent tax rate applicable to qualified personal service corporations.
Donna Joyner-Rodgers (an officer), for petitioner.
Derek W. Kaczmarek, for respondent. - 2 - SWIFT, Judge: Respondent determined deficiencies of $11,903
and $5,003, respectively, in petitioner’s Federal income taxes
for petitioner’s tax years ending June 30, 2002 and 2003.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
The issue for decision is whether petitioner’s tax return
preparation and bookkeeping services are to be treated as
accounting services. If so, petitioner will be treated as a
qualified personal service corporation under section 448(d)(2)
and will be subject to the flat 35-percent tax rate set forth in
section 11(b)(2).
FINDINGS OF FACT
Most of the facts have been stipulated and are so found.
At the time the petition was filed, petitioner’s principal
place of business was located in Las Vegas, Nevada.
In 1978, Steve Rodgers (Rodgers) incorporated petitioner as
a Nevada corporation, and until his death in 2002 Rodgers owned
all of petitioner’s stock. Petitioner’s business consisted of
providing tax return preparation and bookkeeping services, which
services Rodgers and other individuals provided as petitioner’s
employees.
Over the years, Rodgers, on petitioner’s behalf, increased
the number of petitioner’s clients and the number of employees to
perform for petitioner’s clients tax return preparation and - 3 - bookkeeping services, and eventually petitioner opened two
additional offices in the Las Vegas area.
After Rodgers’ death in 2002, Rodgers’ wife, Donna Joyner-
Rodgers (Joyner-Rodgers), succeeded Rodgers as petitioner’s
president and assumed management of petitioner and of
petitioner’s three offices. Also, after Rodgers’ death
petitioner’s stock was owned by Rodgers’ estate, and then in
2004, petitioner’s stock was transferred from Rodgers’ estate to
Joyner-Rodgers.
In addition to her administrative and managerial
responsibilities relating to petitioner, Joyner-Rodgers, as an
employee of petitioner, also provides to petitioner’s clients tax
return preparation services.
During the years in issue, petitioner’s tax return
preparation services generally consisted of the preparation of
clients’ Federal and State individual, corporate, partnership,
gift, and estate tax returns. Petitioner’s bookkeeping services
generally consisted of the preparation, from client records, of
profit and loss statements and various other reports and forms
relating to client Federal payroll taxes, State unemployment
taxes, and sales taxes.
Petitioner is not a public accounting firm, and petitioner’s
employees do not perform services that require petitioner’s
employees to obtain Certified Public Accountant (C.P.A.) - 4 - licenses. Neither Rodgers nor Joyner-Rodgers ever held C.P.A.
licenses.
For the years in issue, petitioner’s employees (including
Rodgers and Joyner-Rodgers) spent all of their work-related time
performing for petitioner’s clients tax return preparation and
bookkeeping services and related administrative and support
services.
On each of petitioner’s timely filed corporate Federal
income tax returns, petitioner’s income tax liability was
calculated using the section 11(b)(1) graduated income tax rates
applicable to corporations.
On April 14, 2005, respondent issued to petitioner a notice
of deficiency in which respondent determined that petitioner’s
tax return preparation and bookkeeping services constituted
accounting services and therefore that petitioner, for the years
in issue, should be treated as a qualified personal service
corporation subject to the flat 35-percent tax rate set forth in
section 11(b)(2). The amounts of the deficiencies herein
represent the increase in petitioner’s Federal income taxes as a
result of applying the flat 35-percent tax rate.1
1 For the years in issue, 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). - 5 - OPINION
In general, for Federal income tax purposes, corporations
are taxed at graduated income tax rates. Sec. 11(b)(1).
So-called qualified personal service corporations as defined in
section 448(d)(2), however, are taxed at a flat 35-percent income
tax rate. Sec. 11(b)(2).
A corporation is to be treated as a qualified personal
service corporation (1) if substantially all of the corporation’s
activities involve the performance of services in the fields of
“health, law, engineering, architecture, accounting, actuarial
science, performing arts, or consulting” (hereafter covered
services), sec. 448(d)(2)(A); sec. 1.448-1T(e)(4)(i), Temporary
Income Tax Regs., 52 Fed. Reg. 22768 (June 16, 1987) (the
“function test”); and (2) if 95 percent of the corporation’s
stock is owned by, among others, individual employees performing
covered services for the corporation (or by the estate of a prior
employee of the corporation who performed covered services for
the corporation), sec. 448(d)(2)(B); sec. 1.448-1T(e)(5)(i),
Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987)
(the “ownership test”).
Substantially all of a corporation’s activities will be
treated as covered services only if in the aggregate the
corporation’s employees spend 95 percent or more of their time in - 6 - performing covered services. Sec. 1.448-1T(e)(4)(i), Temporary
Income Tax Regs., supra. In calculating the amount of employee
time spent performing covered services, administrative and
support services incident to covered services are treated as
covered services. Id.
Section 448(d)(2), the regulations thereunder, and court
opinions generally do not define accounting services.2 However,
in section 1.448-1T(e)(5)(vii), Example 1(i), Temporary Income
Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987), the preparation of
tax returns and audit and financial statements are treated as
accounting services:
X, a corporation, is engaged in the business of providing accounting services to its clients. These services consist of the preparation of audit and financial statements and the preparation of tax returns. For purposes of section 448, such services consist of the performance of services in the field of accounting. * * *
Petitioner concedes that, if tax return preparation and
bookkeeping services constitute accounting services, by virtue of
Rodgers’ and Rodgers’ estate’s ownership of petitioner’s stock,
the above ownership test has been satisfied.
2 In Ron Lykins, Inc. v. Commissioner, T.C. Memo. 2006-35, the parties did not dispute that tax return preparation services constituted accounting services. - 7 -
Petitioner, however, argues that, for purposes of section
448(d)(2)(A), tax return preparation and bookkeeping services do
not constitute accounting services, that petitioner therefore
does not meet the above function test, and that petitioner should
not be treated as a qualified personal service corporation.
Petitioner argues that under Nevada law, accounting
services can be performed only by C.P.A.s, and that because
petitioner is not a C.P.A. firm, does not employ C.P.A.s, and
does not perform services which are restricted under Nevada law
to C.P.A.s, petitioner should not be treated as performing
accounting services.
In essence, petitioner would treat only those services which
require a C.P.A. license as accounting services and would treat
other tax return preparation and bookkeeping services as
nonaccounting services.
We disagree with petitioner’s overly restrictive definition
of accounting services.
Petitioner fails to appreciate the distinction between
“public accounting” and “accounting”. Public accounting, which
generally consists of the preparation and/or audit of financial
statements, and generally requires a C.P.A. license, represents a
branch of accounting, not the entire realm of accounting. See
Weygandt, et al., Accounting Principles, 6-9 (3d ed. 1993). - 8 -
Further, section 448(d)(2) requires only that the services
be in the “field of accounting” and is not limited to public
accounting. Historically, tax return preparation and bookkeeping
services are regarded as within the field of accounting.
Accounting has been defined as:
the process of recording transactions in the financial records of a business and periodically extracting, sorting, and summarizing the recorded transactions to produce a set of financial records. * * * [Blacks’s Law Dictionary 21 (8th ed. 2004).]
Tax return preparation, which requires extracting
information relating to financial transactions, analyzing that
information, and then summarizing and reporting that information
on a tax return, fits within the above general definition of
accounting.
Also, as discussed above, section 1.448-1T(e)(5)(vii),
Example 1(i), Temporary Income Tax Regs., supra, indicates that,
for purposes of section 448(d)(2), tax return preparation
services are to be treated as accounting services.
We note that under Nevada statutory law “public accounting”
includes “the preparation of tax returns”. Nev. Rev. Stat. Ann.
sec. 628.023 (Lexis Nexis 2004).
We note further that a defining characteristic of our
Federal income tax system is the reporting of financial - 9 - transactions within “annual accounting periods”. Sec. 441(c).
Tax professionals and the Internal Revenue Code itself generally
regard the process of determining in which annual accounting
period revenues and expenditures are to be recognized as tax
accounting. See generally secs. 441 through 483.
A significant aspect of petitioner’s tax return preparation
services consists of assisting clients in properly recognizing
and reporting revenue and expenditures in the appropriate tax
year or, in other words, performing tax accounting services.
We conclude that petitioner’s tax return preparation
services, for purposes of section 448(d)(2), constitute services
within the field of accounting.
Bookkeeping, which section 448 and the regulations
thereunder do not address, has been defined elsewhere as:
a branch of accounting that deals with the systematic classification, recording, and summarizing of business and financial transactions in books of account. * * * [Webster’s Third New International Dictionary (1981).]
Not only does bookkeeping constitute a “branch” of
accounting, but our system of double entry bookkeeping undergirds
modern financial accounting.3
3 Historians generally consider Luca Pacioli (1445-1514 or 1517) to be “The Father of Accounting” for first documenting in his work Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Venice 1494), the process of double entry bookkeeping. - 10 - We sustain respondent’s determination that tax return
preparation and bookkeeping services constitute and are to be
treated as services in the field of accounting. Substantially
all of petitioner’s employees’ activities involve the performance
of services in the field of accounting. Accordingly, for the 2
years in issue, petitioner is to be treated as a qualified
personal service corporation taxed at the flat 35-percent rate
set forth in section 11(b)(2).
To reflect the foregoing,
Decision will be entered
for respondent.