The opinion
T.C. Summary Opinion 2007-48
UNITED STATES TAX COURT
ROBERTSON STRONG & APGAR ARCHITECTS, PC, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12504-05S. Filed March 26, 2007.
Lawrence Apgar (an officer), for petitioner.
John Janusz, for respondent.
GOLDBERG, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Pursuant to section
7463(b), the decision to be entered is not reviewable by any
other court, and this opinion should not be treated as precedent
for any other case. Unless otherwise indicated, subsequent
section references are to the Internal Revenue Code in effect for
the years in issue, and all Rule references are to the Tax Court
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Rules of Practice and Procedure.
Respondent determined deficiencies in petitioner’s Federal
income taxes for taxable years 2002 and 2003 in the amounts of
$10,021.60 and $11,841.60, respectively. The issue for decision
is whether petitioner was a personal service corporation in the
tax years in question and accordingly subject to a special flat
tax rate of 35 percent.
Background
This case was submitted fully stipulated pursuant to Rule
122. The stipulation of facts and the attached exhibits are
incorporated herein by reference. At the time the petition was
filed, petitioner’s place of business was in Syracuse, New York.
Petitioner filed a Form 1120, U.S. Corporation Income Tax
Return, for the taxable years 2002 and 2003.
At all times during 2002 and 2003, petitioner was
incorporated under the laws of New York. Petitioner’s shares at
the end of both of the years at issue were held as follows:
Lawrence Apgar 122 shares
James Oliver 50 shares
Treasury shares 172 shares
On Schedule E1 of the Form 1120, however, filed for taxable
1
Schedule E, Compensation of Officers, of Form 1120
requires the corporation to provide certain information,
including the names of officers, and the percentage of
corporation stock owned by each officer.
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years 2002 and 2003, petitioner indicated that its sole
officers, Lawrence Apgar and James S. Oliver, owned 70.5 percent
and 29.5 percent, respectively, of all of the outstanding common
stock of the corporation. Petitioner acquired outstanding
shares of its stock sometime in 2002. According to the Schedule
L, Balance Sheets per Books, of Form 1120 filed for taxable year
2002, petitioner’s cost of treasury stock was $40,666 at the
beginning of 2002 and was $53,999 at the end of 2002. When
these acquired shares were added to the shares already held by
petitioner as treasury stock, the total number of shares was
172. Petitioner’s cost of treasury stock on its Schedule L of
Form 1120 for 2003 was the same for the beginning and end of
that year, $53,999.
Discussion
In general, for Federal income tax purposes, corporations
are taxed at graduated income tax rates. Sec. 11(b)(1).
So-called qualified personal service corporations as defined in
section 448(d)(2), however, are taxed at a flat 35-percent
income tax rate. Sec. 11(b)(2). The term “qualified personal
service corporation” is defined in section 448(d)(2). A
corporation will be considered a qualified personal services
corporation if it meets two tests: a function test and an
ownership test. Sec. 448(d)(2)(A) and (B). Section
448(d)(2)(A) defines the function test as where “substantially
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all of the activities of which involve the performance of
services in the fields of * * * architecture.” In this case,
petitioner and respondent agree that petitioner’s business
satisfies the function test. With regard to the ownership test,
respondent contends that petitioner also satisfies the ownership
test; petitioner disagrees.
Section 448(d)(2)(B) defines the ownership test as where:
(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)
In interpreting the ownership test of section 448(d)(2)(B),
section 1.448-1T(e)(5)(i), Temporary Income Tax Regs., 52 Fed.
Reg. 22768 (June 16, 1987), as amended by T.D. 8329, 56 Fed.
Reg. 485 (Jan. 7, 1991), and T.D. 8514, 58 Fed. Reg. 68299 (Dec.
27, 1993), further provides:
A corporation meets the ownership test, if at all
times during the taxable year, substantially all of
the corporation’s stock, by value, is held, directly
or indirectly, by–
(A) Employees performing services for
such corporation in connection with
activities involving a field referred to in
paragraph (e)(4) of this section,
* * * * * * *
For purposes of this paragraph (e)(5), the term
“substantially all” means an amount equal to or
greater than 95 percent.
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Petitioner argues that the treasury shares should be taken
into consideration when applying the percentage ownership test
as set forth in section 448(d)(2)(B) and section 1.448-
1T(e)(5)(i), Temporary Income Tax Regs., supra. Under
petitioner’s argument, percentage of ownership would be as
follows:
Lawrence Apgar 35.5 percent
James Oliver 14.5 percent
Treasury shares 50 percent
Petitioner maintains that although the treasury shares were
not outstanding shares, they nonetheless had a “contra value”2
of $53,999 at the end of its 2002 and 2003 taxable years.
Accordingly, says petitioner, due to this “value”, the shares
should be considered as held by “by value” pursuant to section
44(d)(2)(B) and therefore included when applying the ownership
test as described in section 1.448-1T(e)(5)(i), Temporary Income
Tax Regs., supra.
Petitioner’s rationale may be summarized as follows:
First, petitioner argues that it should not be bound for
2
We are unclear as to petitioner’s use of the term contra
value. Petitioner appears to concede that although the treasury
shares are not outstanding equity per se to the corporation, that
they nonetheless have a value (contra value), based on what
petitioner paid to its shareholders upon acquisition of the
shares. We believe that petitioner may be mistakenly
interchanging its concept of contra equity with the term contra
equity account.
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purposes of determining ownership under section 448(d)(2)(B) by
the shares listed on Schedule E of Form 1120, as that Form only
solicits information regarding the ownership of stock by
officers of the corporation in relationship to each other and
not the corporation’s full stock-ownership profile. Second,
petitioner argues that its treasury shares should be
characterized as “by value” pursuant to section 1.448-
1T(e)(5)(i), Temporary Income Tax Regs., supra, because under
New York law, the shares were acquired and retained by the
corporation, and the amount that they were acquired for
($53,999) establishes a present value to the corporation. We
disagree.
Petitioner’s argument that it did not include treasury
shares on Schedule E of the Form 1120 because Schedule E only
asks for shares held by corporation officers “in relation to one
another” is incorrect and meritless. While Schedule E does
solicit information with respect to the shares held by officers,
it clearly asks in sections (d) and (e) for the percentage of
total corporation stock owned by each officer. The corporation
is asked to provide the percentage of the total stock owned by
the officers and not, as petitioner argues, the percentages of
stock each owns in relationship to the other. Accordingly,
petitioner correctly indicated on its Forms 1120 for 2002 and
2003 that Mr. Apgar and Mr. Oliver together owned 100 percent of
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the corporation’s outstanding stock. If petitioner intended the
treasury shares to be included in the total shares of
corporation stock listed on Schedule E, then it would have
listed the percentages owned by Mr. Apgar and Mr. Oliver
accordingly. For example, petitioner alleges that the total
number of common stock shares was 344, with Mr. Apgar holding
122 shares, Mr. Oliver holding 50 shares, and each then owning
35.5 percent and 14.5 percent of the total shares, respectively.
Petitioner, however, did not indicate these ownership
percentages on its Schedule E for either 2002 or 2003.
Petitioner next argues that it indicated the percentages of
each officer’s stock ownership in relation to the other because
the directions attached to Schedule E require that it list “the
deductible part of each officer’s compensation”. This argument,
however, has no relationship to the percentage of stock owned by
the officers but rather deals exclusively with the total
compensation of officers as indicated on Schedule E, section
(f). Accordingly, we cannot conclude that there is merit in any
of petitioner’s arguments with respect to its completed
Schedules E.
Petitioner next argues that the 172 shares of treasury
stock should be factored into the ownership test as described in
section 448(d)(2)(B) and section 1.448-1T(e)(5)(i), Temporary
Income Tax Regs., 52 Fed. Reg. 22766 (June 16, 1987), as the
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shares held a ‘contra value’ to petitioner in both tax years of
$53,999. We disagree.
New York Business Corporation Law sec. 102(a)(14) (McKinney
2003) defines treasury shares as: “shares which have been
issued, have been subsequently acquired, and are retained
uncancelled by the corporation. Treasury shares are issued
shares, but not outstanding shares, and are not assets.”
Petitioner argues that even though it purchased the
acquired shares, and the shares remain uncanceled, they
nonetheless have a ‘contra value’, and, while not assets, the
shares are still held “by value” in accordance with section
448(d)(2)(B) and section 1.448-1T(e)(5)(i), Temporary Income Tax
Regs., supra. We disagree with petitioner’s creative
characterization of its treasury shares.
Treasury stock, while held by a corporation, has no value.
Christie v. Fifth Madison Corp., 211 N.Y.S.2d 787, 796 (App.
Div. 1961). Treasury stock has no value because it carries no
voting rights, rights to dividends, or rights to distributions.
Id. Treasury shares are actually a legal fiction and a figure
of speech only used to explain the rights and rules that apply
upon their reissue. Id. at 796. Treasury stock, therefore, is
not an “asset” of the corporation. Its only value is what
petitioner might receive in consideration for its reissuance.
In this case, when petitioner acquired its stock, the stock
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could be reissued for consideration (i.e., cash), and the cash
would increase its assets and the reissued shares would be
reflected in an increase in its shareholder equity.
Most importantly, contrary to petitioner’s assertion, the
acquisition of treasury stock is actually a contraction of
corporate capital. Specifically, in this case, when petitioner
reacquired shares in 2002, the total cost of its treasury stock
was $53,999. On the Schedule L balance sheets for 2002 and
2003, petitioner correctly subtracted $53,999 from its retained
earnings. This calculation was done because when stock is
reacquired by a corporation there is a necessary and
corresponding reduction in retained earnings and shareholder
equity. The treasury stock is held in a contra equity account,
so named because it reduces total shareholder equity in the
corporation. Only a subsequent resale of treasury stock would
result in an expansion of shareholder equity. It follows then
that because treasury stock has no value if and until it is
resold, that it is not held “by value” per section 448(d)(2)(B).
In this case, the only stock which was held “by value” is
the stock owned by Mr. Apgar and Mr. Oliver. Because Mr. Apgar
and Mr. Oliver are petitioner’s employees, and as they together
hold 100 percent of petitioner’s stock, petitioner meets the
ownership test defined in section 1.448-1T(e)(5)(i), Temporary
Income Tax Regs., supra.
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Finally, we note that because New York corporation law
provides that petitioner, a professional service corporation
engaged in architectural services, may issue shares only to
individuals who are licensed architects in New York State, we
suspect that the treasury shares at the heart of this case were
reacquired by petitioner from Mr. Apgar and Mr. Oliver for the
purpose of circumventing the ownership test of section
448(d)(2)(B) and hence, avoiding application of the 35-percent
flat tax. N.Y. Bus. Corp. Law sec. 1507 (McKinney 2003).
Accordingly, we sustain respondent’s determination.
Decision will be entered
for respondent.