Mapping the Scope of Personal Service Corporations

The Tax Court held that a land surveying company was a personal service corporation subject to a 35% flat income tax rate because it was engaged in engineering, despite the fact that it performed no work requiring an engineering license under state law.

Section 448 requires most C corporations to use the accrual method of accounting but exempts “qualified personal service corporations.” Section 11(b)(2) imposes a flat 35% tax rate on personal service corporations rather than allowing them to use the progressive rate structure provided for most other corporations.

A personal service corporation is one that provides services in any of eight fields listed in section 448(d)(2), including engineering. The others are accounting, law, consulting, actuarial science, health, architecture and performing arts.

Kraatz & Craig Surveying Inc. was a Tennessee corporation whose sole activity was land surveying. It filed its tax return as a general corporation and not as a personal service corporation. The IRS determined that it was a personal service corporation because Temp. Treas. Reg. § 1.448-1T(e)(4)(i), setting forth a “function test” for determining whether a corporation’s services are qualified personal services, states that engineering includes surveying and mapping. The IRS determined a deficiency of $9,762 for the company’s return for 2005.

The taxpayer argued it was not engaged in engineering because, under Tennessee law, engineers and surveyors are separately licensed and regulated and that it did not employ any licensed engineers, was not associated with any firm that employed licensed engineers, and did not provide any services that Tennessee law required to be performed only by a licensed engineer. Therefore, Kraatz & Craig argued, the temporary regulations’ inclusion of mapping and surveying with engineering was inapplicable or the regulation invalid.

The Tax Court applied the Chevron doctrine (Chevron USA Inc. v. NRDC, 467 U.S. 837 (1984)) to determine the validity of the regulations. Under this doctrine, if the Tax Code is clear, the rule will be enforced as written. If the Code is ambiguous, deference will be given to regulations that adopt a reasonable interpretation of the statute.

None of the eight fields listed in the Code as personal services, including engineering, are defined. Therefore, the court said, it is possible to consider the Code section ambiguous. However, the Tax Court again cited Chevron for the position that, if the intent of Congress in enacting the provision is clear, that eliminates any ambiguity, and regulations consistent with this intent are valid and enforceable. The conference report discussing the adoption of the personal service corporation rules specifically mentions that mapping and surveying are subsets of engineering. Therefore, according to the court, the regulation is a valid interpretation of the Code section. The fact that Congress adopted a rule that is contrary to state law is immaterial. The Tax Code, not state law, governs.

By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accounting, University of Alabama, Tuscaloosa.

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