A, Inc., provided tax return preparation and bookkeeping services for R and other individuals. R, A’s president, owns all of its stock and provides administrative and managerial services to A as an employee, in addition to tax return services. A is not a public accounting firm; A’s employees do not perform services that require CPA licenses under state law. R has never held a CPA license.
A calculated its income tax liability using the Sec. 11(b)(1) graduated corporate income tax rates. However, the Service determined that A is a qualified personal service corporation (PSC) subject to the flat 35% rate in Sec. 11(b)(2), because its return preparation and bookkeeping services constituted accounting services.
Analysis
Qualified PSCs are taxed at a flat 35% income tax rate under Sec. 11(b)(2). A corporation is a qualified PSC if:
- Substantially all of its activities involve the performance of services in the fields of “health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting” (covered services) (Sec. 448(d)(2)(A) and Temp. Regs. Sec. 1.448-1T(e)(4)(i)); and
- 95% 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 who performed covered services for the corporation) (ownership test) (Sec. 448(d)(2)(B) and Temp. Regs. Sec. 1.448-1T(e)(5)(i)).
Administrative and support services incident to covered services are treated as covered services. However, A argues that tax return preparation and bookkeeping services do not constitute accounting services under Sec. 448(d)(2)(A), because (1) it does not perform accounting services under state law, (2) accounting services can be performed only by CPAs and (3) A is not a CPA firm and does not employ CPAs.
In essence, A would treat only those services that require a CPA license as accounting services and would treat other tax return preparation and bookkeeping services as nonaccounting services. However, under Sec. 448(d)(2), services in the “field of accounting” are not limited to public accounting. Accounting is 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 (Black’s Law Dictionary (West Group, 8th ed., 2004), p. 21). Historically, tax return preparation and bookkeeping services are regarded as being within the field of accounting.
Tax Preparation
Tax return preparation fits within the above general definition of accounting. In fact, Temp. Regs. Sec. 1.448-1T(e)(5)(vii), Example 1(i), indicates that, for Sec. 448(d)(2) purposes, tax return preparation services are to be treated as accounting services. Also, according to Nevada statutory law, “public accounting” includes “the preparation of tax returns” (Nev. Rev. Stat. Ann. Section 628.023). Moreover, tax professionals and the Code itself generally regard the process of determining the annual accounting period in which to recognize revenues and expenditures as tax accounting; see Secs. 441–483.
A significant aspect of A’s tax return preparation services consists of assisting clients in properly recognizing and reporting revenue and expenditures in the appropriate tax year (in other words, performing tax accounting services). Thus, A’s tax return preparation services, for purposes of Sec. 448(d)(2), constitute services within the field of accounting.
Bookkeeping
Bookkeeping, which Sec. 448 and the regulations 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 (Merriam Webster, 1981)). Not only does bookkeeping constitute a “branch” of accounting, but our system of double-entry bookkeeping undergirds modern financial accounting.
Conclusion
A’s tax return preparation and bookkeeping services constitute accounting services, even if not provided by CPAs. Thus, A is a qualified PSC taxed at the 35% rate.
Rainbow Tax Service, Inc., 128 TC No. 5 (3/8/07)
