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Professional Services Corporation in consolidated return not subjected to flat rate tax. When a professional business – law, medicine, consulting, engineering, architecture, actuarial science, performing arts, or accounting – is operated as a C corporation, the “professional service corporation” rules tax its income at a flat 35%. It is denied the use of the 15, 25 and 34% brackets otherwise available.
A corporation is a Qualified Personal Service Corporation (QPSC) subject to the flat 35% rate if it passes (or fails, depending on how you look at it) two tests:
– Substantially all of its activities involve the performance of personal services, and
– 95% of the shares are held by employees who performed such services.
An engineer and his wife operated an engineering practice in a C corporation. This C corporation owned 100% of the stock of a ranching business. The tax law allows C corporation parent corporations to file consolidated returns with their subsidiaries, reporting all of the income on one return. On a consolidated bases, the ranch activity caused the company to not have “substantially all” of its activities involve performing personal services. As a result, it filed its return using the lower brackets.
The IRS came in with a novel argument. It said the QPSC tests had to be applied separately to each group member — not to the consolidated return as a whole. On that basis, the engineering business would have to pay up its taxes at a flat 35% rate. Tax Court Judge Jacobs explains:
Respondent asserts that where one member of an affiliated group is a qualified personal service corporation and another is not, the consolidated taxable income of the affiliated group must be broken up into two separate baskets. Respondent argues that section 448 requires that the determination as to whether a corporation is a qualified personal service corporation is to be made at the entity level, not at the level of the affiliated group. Further, respondent posits that the Code provides for treating qualified personal service corporate members of an affiliated group differently from other members.
The Tax Court decided that the tax law fails to support the IRS here:
Although section 448(d)(4) provides special rules by which members of an affiliated group may determine their status as a qualified personal service corporation in electing whether to use the cash method of accounting, it provides no illumination as to the rate of tax to be applied to the consolidated taxable income of the entire group. Nor does section 448(d)(4) provide support for the proposition that the consolidated taxable income of an affiliated group is to be broken up into separate baskets.
The court also found that the consolidated return regulations don’t provide for a breakout of QPSC income from other income:
In computing the proper tax liability of an affiliated group, we begin with section 1.1502-2, Income Tax Regs. Section 1.1502-2(a), Income Tax Regs., does not distinguish between taxable income under section 11(b)(1) and (2), and we find no authority to permit the breakup of an affiliated group’s consolidated taxable income into separate baskets. We look to the affiliated group as a whole, i.e., the entity which generated the consolidated taxable income, to determine the characterization of the consolidated taxable income. And in this regard, the parties agree that, when viewed as a whole, Applied Research’s affiliated group is not a qualified personal service corporation.
To conclude, we hold that in the situation involved herein, graduated rates set forth in section 11(b)(1) should be applied to the affiliated group’s consolidated taxable income. I
I’m surprised the IRS even made this argument. To me, it doesn’t even seem like a close issue. It’s the sort of assertion the IRS can make without risk, because it isn’t subject to the same penalties for taking unsupported positions that apply to taxpayers. A sauce for the gander rule, allowing taxpayers to collect the same penalties for bad positions asserted by IRS that they can assert against taxpayers, is overdue.
Cite: Applied Research Associates, Inc., 143 T.C. No. 17.
Yes, Smith’s tax break does take money out of Jones’s pocket. Fans of corporate welfare tax credits sometimes argue that nobody gets hurt when a favored business gets a sweetheart deal. But their competitors who don’t get the sweet deal may not agree. An Iowa City grocer sure doesn’t:
New Pioneer Food Co-op is crying foul over the idea of the city of Iowa City providing $1.75 million in tax-increment financing assistance to attract a national grocery chain.
New Pioneer’s board of directors sent a letter to the Iowa City Council’s Economic Development Committee this week saying that using TIF money to bring an out-of-state company to Iowa City would hurt local grocers.
These tax breaks — like the state income tax credits the Governor likes to hand out — take money from existing taxpayers to lure and subsidize their competitors — a point not lost New Pioneer:
New Pioneer’s board said if the city were to approve the TIF assistance, it would be at the expense of existing local businesses that would lose customers and be essentially subsidizing a competitor with their tax dollars.
“The market for groceries in the Johnson County area is fixed, and already very competitive,” the board said in its letter. “Bringing in an additional competitor in this category will not drive economic development in the city. It will not increase the size of the market, nor will it increase employment in Johnson County since one or more other stores likely will be forced to eliminate jobs to match their reduced market shares.”
But that’s no concern of the politicians handing out the breaks:
[Iowa City Economic Development Administrator] Davidson said although he respects New Pioneer’s perspective, it’s appropriate for the city to get involved because the project would have a significant impact on the taxable value of the Iowa City Marketplace and properties in the surrounding commercial district.
In other words, screw you guys who are already here paying taxes. We want to give away your money because we think it will enable us to collect more somewhere else in town.
Fresh Friday Buzz! from Robert D. Flach, including word on the upcoming extender train wreck.
Paul Neiffer, Time Running Out on Late Portability Elections. If a taxpayer wants to carry over a deceased spouse’s unused estate tax exclusion, they have to file an election by December 31 for deaths in 2012 or 2013. This filing requirement is, of course, stupid.
Kay Bell, Tax extenders delay could delay 2015 filing season
Jason Dinesen, Move Up the W-2 Filing Deadline to Combat ID Theft? “Moving up the W-2 deadline should be done and it might be a partial fix to the problem of identity theft … but it’s one piece of a solution, not a cure-all.”
Peter Reilly, Teresa Giudice’s Surprise Sentence And Possible Better Ways To Motivate Compliance. “What I found interesting in this piece by Kelly Phillips Erb was that Ms. Giudice was surprised when she was sentenced to some prison time.” Me too.
TaxGrrrl has more guest posts: “Tisha,” Giving Up Citizenship Because Of Taxes; and Matthew Litz, The Inverted Talk About Tax Inversions — They’ve Got it All Upside-Down.
Keith Fogg, Unrecorded Conveyances and the Attachment of the Federal Tax Lien or Innocent Spouse Once Removed (Procedurally Taxing)
A map of per-return Iowa Earned Income Credit by Iowa School District, courtesy Iowa Taxpayers Association and the Legislative Services Agency:
Click image for full-size map.
TaxProf, The IRS Scandal, Day 519
Andrew Lundeen, The Tax Code Isn’t Good at Fighting Inequality (Tax Policy Blog):
A recent article on Vox, How Sweden Fights Inequality—Without Soaking the Rich, notes that countries with the most success in fighting inequality do not have highly progressive tax systems, such as the United States’ tax code.
Inequality is just something our politicians use as a distraction from their own failure to improve the lot of the poor.
News from the Profession. Deloitte So Desperate to Populate Its LinkedIn Group They’ve Resorted to Bribery (Adrienne Gonzalez, Going Concern). So where’s my bribe?