35% Flat Tax Hits Non-CPAs

A C corporation that provides accounting services doesn’t have to be owned by or employ CPAs to be taxed at the flat 35% personal-services corporation rate of section 11(b)(2), according to a recent Tax Court ruling. In Rainbow Tax Service, Inc. v. Commissioner, 128 T.C. No. 5, the taxpayer was assessed deficiencies of $11,903 and $5,003 for tax years 2002 and 2003 because the IRS determined the taxpayer’s business of providing bookkeeping services and preparing tax returns was a “qualified personal services corporation” under section 448(d)(2). In support of that determination, the IRS said “substantially all of the activities” of the taxpayer were in the field of accounting. See section 448(d)(2)(A).

Rainbow, a Nevada company, argued that state law restricts accounting services to licensed CPAs. Since Rainbow did not offer services that state law authorized only CPAs to perform and did not employ any CPAs, Rainbow said it was entitled to use the graduated corporate income tax rates of section 11(b)(1).

The court agreed the taxpayer was not a public accounting firm and its services were restricted by state law, but it said section 448(d)(2) requires only that the services be in the “field of accounting,” not that they be performed by CPAs. Since tax return preparation and bookkeeping are clearly “branches” of accounting under Treasury Regulation 1.448-1T(e)(5)(vii), example 1(i), the court concluded Rainbow was a personal-services corporation and must pay the flat 35% tax rate.

Prepared by JofA Copy Editor Jeffrey Gilman, J.D.