Calpo Hom & Dong Architects, Inc. v. Comm'r

(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. *146 1.448-1T(e)(5), Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987).

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) 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*147 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 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*148 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 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*149 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, 54 S. Ct. 8, 78 L. Ed. 212, 1933-2 C.B. 112 (1933). As described below, petitioner failed to meet its burden.

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 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.

*151 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 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*152 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*153 problems with petitioner's approach. First, other than Mr. Hom's testimony, petitioner presented no 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*154 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 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' *155 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 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*156 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 under section 448(d)(2), thus subject to a flat 35-percent tax rate under*157 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.