Felton v. Comm'r

T.C. Summary Opinion 2006-153

UNITED STATES TAX COURT

REGINA FELTON, PC, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14333-05S. Filed September 18, 2006.

Regina Felton (an officer), for petitioner.

Diana Hinton, for respondent.

ARMEN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.1 The decision to be entered

1

Unless otherwise indicated, all subsequent section

references are to the Internal Revenue Code in effect for 2001

and 2002, the taxable years in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.

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is not reviewable by any other court, and this opinion should not

be cited as authority.

Respondent determined deficiencies in petitioner’s Federal

income tax for the years 2001 and 2002 in the amounts of

$7,017.50 and $4,962.65, respectively. Respondent also

determined an addition to petitioner’s Federal income tax for

2002 under section 6651(a)(1).2 Petitioner timely filed a

petition with the Court. The issues for decision are whether

petitioner is a qualified personal service corporation subject to

a flat tax rate and whether petitioner is liable for the

additions to tax under section 6651(a)(1).

Background

Some of the facts have been stipulated, and they are so

found. We incorporate by reference the parties’ oral

stipulations at trial and accompanying exhibits.

At the time the petition was filed, petitioner’s principal

place of business was Brooklyn, New York.

Regina Felton (Ms. Felton) is an attorney who has been

engaged in the practice of law since 1978. In 1987, Ms. Felton

2

The notice of deficiency determined an addition to tax

for 2002 under sec. 6651(a)(1) of $1,414.36. However, this

appears to comprise $1,116.60 allocable to sec. 6651(a)(1),

failure to file, and $297.76 allocable to sec. 6651(a)(2),

failure to pay. Because the sec. 6651(a)(2) addition was not

determined in the notice of deficiency and is not properly before

the Court, we decide only the issue of the addition to tax

imposed under sec. 6651(a)(1).

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incorporated petitioner as a New York professional corporation.3

Since petitioner’s incorporation, Ms. Felton has been its sole

shareholder, holding 100 percent of the corporation’s shares. At

all relevant times, the sole activity engaged in by petitioner

was the rendering of legal services. Since 1989, Ms. Felton has

been petitioner’s sole practitioner providing those services.

Petitioner employs a minimal secretarial and/or clerical staff.

Since 1987, petitioner’s certified public accountant,

Raymond Saylor (Mr. Saylor), has prepared petitioner’s corporate

income tax returns. For the years in issue, Mr. Saylor

calculated petitioner’s tax based on the graduated tax rate for

corporations under section 11(b)(1).4 In addition, Mr. Saylor

prepared a Form 7004, Application for Automatic Extension of Time

to File Corporation Income Tax Return (extension request), for

petitioner’s calendar year 2002 income tax return and delivered

3

Attorneys are not permitted to incorporate as traditional

corporations under New York State law. See N.Y. Jud. Law sec.

495(1) (McKinney 2006); see also In re Co-operative Law Co., 92

N.E. 15 (N.Y. 1910). Rather, to incorporate a law firm, the

professional corporation provisions must be followed. See N.Y.

Bus. Corp. Law sec. 1503 (McKinney 2006).

4

Sec. 11(b)(1) imposes a tax on the taxable income of

every corporation as follows:

(A) 15 percent of so much of the taxable income as does

not exceed $50,000,

(B) 25 percent of so much of the taxable income as

exceeds $50,000 but does not exceed $75,000,

(C) 34 percent of so much of the taxable income as

exceeds $75,000 but does not exceed $10,000,000, and

(D) 35 percent of so much of the taxable income as

exceeds $10,000,000.

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it to Ms. Felton, instructing her to sign it and mail it to the

Internal Revenue Service. The IRS never received it.

Petitioner filed its Form 1120, U.S. Corporation Income Tax

Return, for the calendar year 2002 on January 13, 2004.

In the notice of deficiency, respondent determined that

Regina Felton, PC is a qualified personal service corporation

subject to a special flat income tax rate of 35 percent.

Petitioner filed a petition with the Court challenging

respondent’s determination, stating:

I operate a law office as a sole practitioner. For the

years 2001 and 2002, it is alleged my taxes were

calculated improperly. The Revenue Agent advised that

pursuant to IRC 448(d)(2), IRC 11 and 3121(d), the

company should pay a “flat tax” of 35%. My accountant

disagrees. The recalculation of the tax under the flat

tax causes a substantial increase in tax on diminimus

[sic] gross income.

Discussion

For the reasons discussed below, we agree with respondent

and decide that petitioner is a qualified personal service

corporation under section 448(d)(2) and is therefore responsible

for the income tax deficiencies determined by respondent for the

calendar years 2001 and 2002. We also decide that petitioner is

liable for the section 6651(a)(1) addition to tax determined by

respondent for the late filing of its 2002 return.

A. Burden of Proof

Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving those

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determinations wrong.5 Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). Petitioner did not meet this burden and, in

fact, “[p]etitioner has not established the factual allegations

in its petition which are material and essential.” Wichita

Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),

affd. 162 F.2d 513 (10th Cir. 1947). Petitioner offered no

persuasive evidence to support its claims and refute respondent’s

determination. See Wood Corp. v. Commissioner, 22 B.T.A. 1182

(1931) (requiring some evidentiary showing because “[t]he

adequate presentation of pertinent facts is the burden assumed by

the petitioner * * *. * * * [and a] decision favorable to its

contentions can not rest on assumption or speculation. It must

rest on facts.”), affd. 63 F.2d 1023 (6th Cir. 1933).

Petitioner’s self-serving assertions are insufficient. See

Tokarski v. Commissioner, 87 T.C. 74, 77 (1986) (stating “we are

not required to accept the self-serving testimony of petitioner *

* * as gospel.”). Petitioner failed to meet its burden of proof,

and, consequently, the Court must side with respondent.

5

The burden of proof may, under certain circumstances,

shift to the Commissioner under sec. 7491(a) if the taxpayer

introduces credible evidence with respect to any factual issue

relevant to ascertaining the taxpayer’s income tax liability.

See Higbee v. Commissioner, 116 T.C. 438, 441 (2001). The burden

of proof is not shifted to respondent in this case, because,

inter alia, petitioner neither alleged that sec. 7491(a) is

applicable nor introduced any credible evidence with respect to

any factual issue relevant to ascertaining its income tax

liability. See id.

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B. Qualified Personal Service Corporation

Respondent contends that petitioner is not eligible for the

graduated income tax rates under section 11(b)(1) because it is a

qualified personal corporation pursuant to section 448(a)(2) and

is instead subject to a flat 35-percent tax rate under section

11(b)(2). In support of this contention, respondent argues that

Ms. Felton, petitioner’s sole shareholder, is an employee of the

corporation. Petitioner, however, contends that Ms. Felton does

not “consider herself” to be petitioner’s employee, and therefore

petitioner is not a qualified personal service corporation under

section 448(d)(2). We agree with respondent.

Section 11(b)(1) generally imposes a tax on the income of a

corporation at a graduated rate. However, qualified personal

service corporations are taxed at a flat 35-percent tax rate.

Sec. 11(b)(2).

Section 448(d)(2) defines a “qualified personal service

corporation” as any corporation:

(A) substantially all of the activities of which

involve the performance of services in the fields of

health, law, engineering, architecture, accounting,

actuarial science, performing arts, or consulting, and

(B) substantially all of the stock of which (by

value) is held directly * * * by--

(i) employees performing services for such

corporation in connection with the activities

involving a field referred to in subparagraph (A),

(ii) retired employees who had performed such

services for such corporation,

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(iii) the estate of any individual described

in clause (i) or (ii), or

(iv) any other person who acquired such stock

by reason of the death of an individual described

in clause (i) or (ii) * * * .

To be a qualified personal service corporation, a

corporation must satisfy two tests under the regulations: the

function test and the ownership test. Sec. 1.448-1T(e)(3), (4),

and (5), Temporary Income Tax Regs., 52 Fed. Reg. 22768 (June 16,

1987), as amended by T.D. 8329, 56 Fed. Reg. 485 (Jan. 7, 1997),

and T.D. 8514, 58 Fed. Reg. 68299 (Dec. 27, 1993). There is no

dispute here that the function test was satisfied because

petitioner’s sole activity was the performance of services in the

field of law.6 See sec. 1.448-1T(e)(4), Temporary Income Tax

Regs., 52 Fed. Reg. 22768 (June 16, 1987), as amended by T.D.

8329, 56 Fed. Reg. 485 (Jan. 7, 1997), and T.D. 8514, 58 Fed.

Reg. 68299 (Dec. 27, 1993). Instead, at the center of this

dispute is whether petitioner satisfied the ownership test.

The ownership test requires that substantially all of the

corporation’s stock is held directly by employees performing the

corporation’s services, here, in the field of law. Sec.

448(d)(2)(B)(i); sec. 1.448-1T(e)(5)(i)(A), Temporary Income Tax

6

The function test requires that 95 percent or more of

corporate employees’ time be spent on providing services in one

of the enumerated fields, which include law. See sec. 1.448-

1T(e)(4), Temporary Income Tax Regs., 52 Fed. Reg. 22768 (June

16, 1987), as amended by T.D. 8329, 56 Fed. Reg. 485 (Jan. 7,

1997), and T.D. 8514, 58 Fed. Reg. 68299 (Dec. 27, 1993).

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Regs., supra. Petitioner contends that it did not satisfy the

ownership test because all of its stock was held by a

nonemployee, Ms. Felton. That said, petitioner has done nothing

to convince us that Ms. Felton is anything other than an

employee.

Section 448(d)(2) does not adequately define the term

“employee”,7 but as a general rule, when Congress has used the

term without defining it, we have concluded that Congress

intended to describe the conventional relationship as understood

by common law. See, e.g., Nationwide Mut. Ins. Co. v. Darden,

503 U.S. 318, 322-323 (1992). Likewise, both the Court and the

Commissioner have adopted common-law rules to distinguish

employees from independent contractors. See Weber v.

Commissioner, 103 T.C. 378, 387 (1994), affd. 60 F.3d 1104 (4th

Cir. 1995); Rev. Rul. 87-41, 1987-1 C.B. 296; see also Nationwide

Mut. Ins. Co. v. Darden, supra at 324. The primary feature in

this analysis is control over the manner and means by which an

employee performs his or her services. See Rev. Rul. 87-41,

supra; see also Clackamas Gastroenterology Associates, P.C. v.

Wells, 538 U.S. 440, 448 (2003) (describing the element of

control as the “principal guidepost”); Ron Lykins, Inc. v.

Commissioner, T.C. Memo. 2006-35.

7

Sec. 1.448-1T(e)(5)(ii), Temporary Income Tax Regs.,

supra, does contain a definition of employee, but it does not

appear to be helpful in these circumstances.

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As the sole stockholder and owner of petitioner, Ms. Felton

controlled the business and controlled which clients to

represent. She also had control over how that representation was

undertaken. Indeed, it was Ms. Felton, petitioner’s only

attorney, that performed all of petitioner’s legal services.

Common experience under these facts tells us that petitioner and

Ms. Felton were one and the same for purposes of control.

In addition, it is important to note that some Internal

Revenue Code provisions include the officers of a corporation in

their definition of employee. See, e.g., sec. 3121(d) (providing

that an officer of a corporation is an employee for employment

tax purposes). When asked, Ms. Felton testified that she does

not “call herself an officer”. The Court, however, takes

judicial notice of the fact that the New York Department of

State, Division of Corporations’ Web site lists Regina Felton as

petitioner’s “Chairman or Chief Executive Officer”. See

http://appsext5.dos.state.ny.us/corp_public/; see also Fed. R.

Evid. 201. Petitioner was asked by the Court to provide a copy

of its original application for incorporation. Petitioner did

not do so. Under New York State law, certificates of

incorporation for professional corporations must list the names

of the corporation’s shareholders, officers, and directors. N.Y.

Bus. Corp. Law sec. 1503 (McKinney 2006). “The rule is well

established that the failure of a party to introduce evidence

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within his possession and which, if true, would be favorable to

him, gives rise to the presumption that if produced it would be

unfavorable.” Wichita Terminal Elevator Co. v. Commissioner, 6

T.C. at 1165. Under Wichita Terminal, the assumption must be

that the incorporation documents would contradict Ms. Felton’s

testimony.

Balanced against Ms. Felton’s unsupported assertions, see

Tokarski v. Commissioner, 87 T.C. at 77, are the facts in this

case establishing that Ms. Felton is the corporate petitioner’s

sole shareholder. She is the sole attorney performing all of the

petitioner law firm’s legal services. Ms. Felton is also

presumed to be the sole officer and/or director of the

corporation.8 It is the opinion of the Court that Ms. Felton is

petitioner’s employee for the purpose of the instant analysis.

Therefore, because all of petitioner’s stock was held

directly by its employee, Ms. Felton, petitioner also satisfied

8

“When all of the issued and outstanding stock of the

corporation is owned by one person, such person may hold all or

any combination of offices.” N.Y. Bus. Corp. Law sec. 715

(McKinney 2006). Aside from Ms. Felton’s being listed with the

New York Secretary of State as petitioner’s chairman or chief

executive officer, New York State law requires that all officers

and directors of a professional service corporation be authorized

to engage in the practice of the profession “which such

corporation is authorized to practice” and is either a

shareholder or “engaged in the practice of his profession in such

corporation.” N.Y. Bus. Corp. Law sec. 1508 (McKinney 2006).

Ms. Felton is petitioner’s sole shareholder, and she testified

that she is the only attorney who performed legal services for

petitioner. None of the clerical or secretarial staff employed

by petitioner is authorized under New York State law to be an

officer or director of the corporation.

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the ownership test. See sec. 448(d)(2)(B)(i); sec. 1.448-

1T(e)(5)(i)(A), Temporary Income Tax Regs., 52 Fed. Reg. 22768

(June 16, 1987), as amended by T.D. 8329, 56 Fed. Reg. 485 (Jan.

7, 1997), and T.D. 8514, 58 Fed. Reg. 68299 (Dec. 27, 1993).

Accordingly, we hold that petitioner is a qualified personal

service corporation under section 448(d)(2) and is subject to the

flat 35-percent tax rate for the years in issue.

C. Addition to Tax

Section 6651(a)(1) imposes an addition to tax for failure to

file a return by its due date. Sec. 6651(a)(1). The addition

equals 5 percent for each month or fraction thereof that the

return is late, not to exceed 25 percent. Id. Respondent bears

the burden of production with respect to the addition to tax.

See sec. 7491(c); see also, e.g., Swain v. Commissioner, 118 T.C.

358, 363 (2002); Higbee v. Commissioner, 116 T.C. 438 (2001).

Respondent has met his burden.

In the absence of an extension, the last date for petitioner

to file its calendar year 2002 return was March 17, 2003. Secs.

6072(b), 7503. Ms. Felton claims to have filed an extension

request, but petitioner has been unable to produce any evidence

that such a request was sent to the IRS. Instead of a retained

copy, Ms. Felton proffered a “simulated” copy of the extension

request filled out on or about March 7, 2006, to demonstrate what

petitioner’s extension request would have looked like had one

been submitted in 2003.

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Assuming, arguendo, that petitioner had timely submitted an

extension request, an extension would have given petitioner until

September 15, 2003, to file its 2002 return. Sec. 6081(a); sec.

1.6081-3, Income Tax Regs. Petitioner’s 2002 return was not

filed, however, until January 13, 2004. The return was still

late. The only bearing an extension would have had on the

instant case would be in the calculation of the addition to tax.

Because we are unpersuaded that a request for an extension of

time to file the return was properly sought, we need not consider

a recalculation of the addition to tax under section 6651(a).

“A failure to file a tax return on the date prescribed leads

to a mandatory penalty unless the taxpayer shows that such

failure was due to reasonable cause and not due to willful

neglect.” McMahan v. Commissioner, 114 F.3d 366, 368 (2d Cir.

1997). A showing of reasonable cause requires taxpayers to

demonstrate they exercised “ordinary business care and prudence”

but were nevertheless unable to file the return within the

prescribed time. United States v. Boyle, 469 U.S. 241 (1975);

sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

In its posttrial memorandum, petitioner contends that the

late filing of its return is attributable to the December 23,

2002, death of Ms. Felton’s mother after a long illness.

A taxpayer may have reasonable cause for failure to timely

file a return where the taxpayer or a member of the taxpayer’s

family experiences an illness or incapacity that prevents the

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taxpayer from filing his or her return. See, e.g., Hobson v.

Commissioner, T.C. Memo. 1996-272 (reasonable cause was found

where taxpayers cared for a seriously ill child and an invalid

parent and taxpayer husband’s job forced taxpayers to live apart

for part of the year); Tabbi v. Commissioner, T.C. Memo. 1995-463

(reasonable cause was found where taxpayers’ son had heart

surgery and taxpayers spent 4 months continuously in the hospital

with him, and taxpayers filed their return 2 months after their

son’s death). In contrast, a taxpayer generally does not have

reasonable cause for his or her failure to timely file a return

where the taxpayer’s illness does not prevent the taxpayer from

filing his or her return. See, e.g., Watts v. Commissioner, T.C.

Memo. 1999-416 (reasonable cause was not found where, although

taxpayer’s mother and daughter were both ill and taxpayer

frequently took them to see doctors, taxpayer also performed

extensive architectural services in taxpayer’s business); Wright

v. Commissioner, T.C. Memo. 1998-224 (reasonable cause was not

found where the taxpayer had capacity to attend to matters other

than filing tax returns despite his mother’s traumatic

disappearance and death and the taxpayer’s failure to file

returns continued beyond the duration of these events), affd.

without published opinion 173 F.3d 848 (2d Cir. 1999).

Although the Court sympathizes with Ms. Felton for the loss

of her mother, petitioner clearly filed its return beyond the

duration of the illness and incapacity, and, in the instant case,

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petitioner provided no information demonstrating the extent to

which Ms. Felton’s family loss prevented the corporation from

filing its return. See Tokarski v. Commissioner, 87 T.C. at 77.

On the basis of the record before us, we therefore conclude that

petitioner did not demonstrate that its failure to timely file a

return was due to reasonable cause and not willful neglect. See

sec. 301.6651-1(c), Proced. & Admin. Regs.; sec. 1.6161-1(b),

Income Tax Regs. Accordingly, petitioner is liable for the

addition to tax under section 6651(a)(1) for 2002.

Conclusion

We have considered all of the other arguments made by

petitioner, and, to the extent that we have not specifically

addressed them, we conclude that they are without merit.

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect our disposition of the disputed issues,

Decision will be entered

for respondent as to the

deficiencies in tax and the

addition to tax under section

6651(a)(1) for 2002 in the

amount of $1,116.60.