                        T.C. Memo. 2007-140



                      UNITED STATES TAX COURT



         CALPO HOM & DONG ARCHITECTS, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4227-05.                Filed June 4, 2007.



     Richard Todd Luoma, for petitioner.

     Christian A. Speck, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined a deficiency of $7,506

in petitioner’s 2002 Federal corporate income tax.   The issue for

decision is whether, during 2002, petitioner was a qualified

personal service corporation as defined by section 448(d)(2).1


     1
         Unless otherwise indicated, all section references are to
                                                    (continued...)
                               - 2 -

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts, the supplemental stipulation of facts,

and the attached exhibits are incorporated herein by this

reference.   At the time it filed its petition, petitioner’s

principal place of business was in Sacramento, California.

     Petitioner, a corporation, offers architectural services and

other related services to its clients.     In its promotional

materials, petitioner describes its services:

     Calpo Hom & Dong Architects (CH&D) offers a full range
     of architectural services, including master planning,
     feasability studies, design, interior design, space
     planning, facilities management, construction
     administration, historic preservation and consulting
     services.

                *    *    *    *       *   *    *

     Our widely diversified practice, encompassing large
     scale planning projects to singular architectural
     projects, affords us the latitude of a wide range of
     knowledge from which we can draw our thoughts.

     Our approach seeks a balanced weighing of elements that
     make up architecture: design, the organization of
     space and light, structure, systems, and materials.

To carry out these services, petitioner employs licensed

architects, unlicensed architects, and nonarchitects.




     1
      (...continued)
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
                              - 3 -

     During 2002, petitioner was owned 100 percent by architects

licensed to practice in the State of California.   Petitioner

timely filed a Form 1120, U.S. Corporation Income Tax Return, for

2002, identifying its business activity as architecture.

Petitioner reported gross receipts of $2,728,291, cost of goods

sold of $850,006, total income of $1,857,382, total deductions of

$1,819,853, taxable income of $37,529, and total tax of $5,629.

To calculate the total tax, petitioner used the graduated tax

rates generally applicable to corporations, as provided in

section 11(b)(1).

     On November 18, 2004, respondent issued petitioner a notice

of deficiency stating:

     It is determined that for the taxable year shown below
     [2002], CALPO HOM & DONG ARCHITECTS INC is a Personal
     Service Corporation that is subject to a special flat
     income tax rate of 35%.

     The corporation is a qualified Personal Service
     Corporation because substantially all of the
     corporation’s activities involve the performance of
     services in the fields of health, law, engineering,
     architecture, accounting, actuarial science, the
     performing arts, or consulting, and substantially all
     of the stock of the corporation is held by employees
     performing services for the corporation, retired
     employees, employees’ or retired employees’ estates or
     persons acquiring stock by reason of an employees’
     death.

Using the flat 35-percent tax rate applicable to qualified

personal service corporations under section 11(b)(2), respondent
                                - 4 -

determined a corrected tax liability of $13,135 and a deficiency

of $7,506 in petitioner’s 2002 Federal corporate income tax.

     In response to the notice of deficiency, petitioner timely

filed a petition with this Court.

                               OPINION

I.   Applicable Code Sections and Regulations

     Section 11(a) imposes a tax on the taxable income of every

corporation.   Section 11(b)(1) provides graduated tax rates

generally applicable to corporations.    However, section 11(b)(2)

provides:   “Notwithstanding paragraph (1), the amount of the tax

imposed by subsection (a) on the taxable income of a qualified

personal service corporation (as defined in section 448(d)(2))

shall be equal to 35 percent of the taxable income.”

     A corporation is a qualified personal service corporation if

it meets both the “function test” and the “ownership test” of

section 448(d)(2).    See sec. 1.448-1T(e)(3), Temporary Income Tax

Regs., 52 Fed. Reg. 22768 (June 16, 1987).    Under the function

test, “substantially all of the activities [of the corporation

must] * * * involve the performance of services in the fields of

health, law, engineering, architecture, accounting, actuarial

science, performing arts, or consulting”.    Sec. 448(d)(2)(A)

(emphasis added).    Section 1.448-1T(e)(4)(i), Temporary Income

Tax Regs., supra, further describes the function test:

     A corporation meets the function test if substantially
     all the corporation’s activities for a taxable year
                                 - 5 -

      involve the performance of services in one or more of
      the following fields--

           (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. 1.448-

1T(e)(5), Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June

16, 1987).

II.   The Parties’ Positions

      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)
                              - 6 -

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 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


     2
        Apparently, petitioner concedes that it meets the
ownership test only if the Court concludes that only one
qualifying field can be considered in applying the function test.
It is unclear why petitioner limits its concession in this
manner. Nevertheless, because we consider only one of the
qualifying fields in determining petitioner failed to meet its
                                                   (continued...)
                               - 7 -

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 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


     2
      (...continued)
burden of proof, see infra, the condition on petitioner’s
concession has been met.
     3
        Petitioner’s classification of services is questionable
for many reasons, not the least of which is that some of the
services petitioner now classifies as nonarchitectural services
were identified as architectural services in its promotional
materials. Any reference below to architectural services and
nonarchitectural services does not constitute a finding by this
                                                   (continued...)
                              - 8 -

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 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 (1933).

As described below, petitioner failed to meet its burden.

III. Analysis

     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




     3
      (...continued)
Court. Instead, such references are used for the purpose of
clarity in demonstrating that, even if petitioner’s
classification were accepted, petitioner would still fail to meet
its burden of proof.
     4
        Under sec. 7491(a), the burden of proof may shift to the
Commissioner in certain situations. Petitioner does not argue
that the burden of proof shifts to respondent.
                               - 9 -

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.

     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



     5
        Petitioner’s architectural services included schematic
design, design development, construction documents and bid
negotiations, construction document support, and specialized
architectural services; petitioner’s nonarchitectural services
included space planning, space planning support, price planning,
interior design, construction administration, specialized
services, and outside consulting.
     6
        We note that petitioner’s revenue summaries indicate
total 2002 revenue of $2,442,122, while its 2002 tax return
indicates gross receipts of $2,728,291. Petitioner does not
explain this discrepancy.
                             - 10 -

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 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 problems with petitioner’s approach.

First, other than Mr. Hom’s testimony, petitioner presented no
                             - 11 -

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 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


     7
        The following project numbers appear on petitioner’s
January 2002 revenue summary: 00137.00; 00184.00; 00203.00;
00209.00; 00223.00; 00268.00; 01014.00; 01049.00; 01070.00;
01089.03; 01089.04; 01097.00; 01133.00; 01134.00; 01147.00;
                                                   (continued...)
                                - 12 -

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’ 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



     7
      (...continued)
01154.00; 01157.00; 01167.00; 01193.00; 01204.00; 01218.00;
01218.01; 01221.00; 01247.00; 01253.00; 01259.00; 01264.00;
01272.00.
     8
        Of the project numbers appearing on petitioner’s January
2002 revenue summary, only the following 10 project numbers
appear on petitioner’s employees’ time sheets for January 2002:
00184.00; 00203.00; 00223.00; 00268.00; 01014.00; 01133.00;
01221.00; 01247.00; 01253.00; 01264.00.
                               - 13 -

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 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
                               - 14 -

under section 448(d)(2), thus subject to a flat 35-percent tax

rate under 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.
