TAX COURT OPINION

Case: Grutman-Mazler Engineering Inc.
Docket Number: 14843-06
Judge: Kroupa
Opinion Type: memo
Filed: 05/21/2008
Pages: 12

T .C . Memo . 2008-14 0 UNITED STATES TAX COUR T GRUTMAN-MAZLER ENGINEERING INC ., Petitioner v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 14843-06 . Filed May 21, 2008 . Gregory Mazler (an officer), for petitioner . Jonathan Sloat , for respondent . MEMORANDUM FINDINGS OF FACT AND OPINIO N KROUPA, Judge : Respondent determined a $1,529 .45 deficienc y in petitioner's Federal income tax for the taxable year ende d October 31, 2004 (the year at issue ) .1 The sole issue fo r '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 . :SERVED MAY 212008 - 2 - 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 tha t 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 o f 2A11 section references are to the Internal Revenue Code in effect for the year at issue, unless otherwise indicated . - 3 - 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 o f 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 als o 3The 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 . spent a small amount of time processing bonds for the engineering - 4 - 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 rat e 4The 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 . - 5 - 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 . ' The Ownership Tes t 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 . 5The 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 . - 6 - 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 engineerin g 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 - 7 - conclude that petitioner meets the ownership test because both owners of petitioner's stock performed services in the engineering field . The Function Tes t 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)(1), 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) . California law defines civil engineering as the following studies - 8 - 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 submittin g 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 ., su ra . Accordingly, activities that are incident to preparing and submitting designs, plans and specifications and engineering reports also constitute qualifying activities . Id . Petitioner's Planning Department undertook activities such - 9 - 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 - 10 - 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 entir e 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 th e 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 - 11 - performed exactly the same amount of services for petitioner . There is no evidence in the record to support this assumption . Petitioner relies on Alron Engq . & 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 Engq . , 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 - 12 - 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 entere d for respondent .