Anyone who’s work involves deciphering the Internal Revenue Code – or any taxpayer who spends time trying to understand it, for that matter – understands that Congress likes to pick “winners” and “losers” when creating tax breaks. While we all enjoy those Code provisions that create winners through tax saving opportunities, just like we all must eat our vegetables along with the more delicious parts of our meal, we also must understand those provisions which cause taxpayers to be losers, if for no other reason than to try to help us avoid losing. Such is the case with the “specified service trade or business” provisions of the new section 199A, Qualified Business Income Deduction (or simply “QBID” for short).
In case you have missed the previous guidance (here and here), the new QBID makes winners out of owners of “pass-through” trades or businesses, which include sole proprietors. Sorry, employees, you are not eligible for the QBID for amounts you receive as wages (although individuals who are both owners of pass-through trades or businesses who are also employees are eligible for the QBID based upon their Qualified Business Income, but never their wages). Those business owners are allowed, under certain circumstances, to claim a twenty percent (20%) deduction for “Qualified Business Income” (or simply, “QBI”). There are a couple significant exceptions – first, a reduced or eliminated QBID awaits those with insufficient wages paid by and insufficient cost basis existing in property used by the trade or business. A second limitation, the topic of today’s article, is the “specified service trade or business” exception. We’ll refer to this as “SSTB” (one more acronym for you to remember).
Before we discuss what defines an SSTB, we can save you some time and reading by asking you to think ahead to your future taxable income amounts shown on Form 1040:
- If you will be married and filing jointly
- If that future taxable income number will be less than $315,000 for 2018 (with indexed increases for future years)
- If you are filing any other type of return (single, married filing separately, or head of household with taxable income of half of that amount, $157,500 for 2018 with annual indexing),
Congratulations! Congress made you a winner. Your QBID is left intact, regardless of whether you have income from an SSTB. Your prize is a deduction worth up to twenty percent (20%) of your QBI. As a bonus, Congress also awarded you the time you won’t need to spend reading the rest of this article or other guidance necessary for you to understand what an SSTB is (unless, like us, you advise others on the SSTB).
Unless Congress made you a winner based on taxable income, as described above, read on – your QBID from SSTB income will be limited or eliminated. In creating the SSTB exception, Congress created a phase-out to separate the winners from the losers which is equal to $100,000 for married filing joint returns, and $50,000 for all other returns. Once taxable income reaches $315,000 plus $100,000 ($415,000) for married filing jointly filers, or $157,500 plus $50,000 ($207,500) (all amounts for 2018 and indexed accordingly in future years), QBI no longer includes SSTB income. If you fall between the thresholds, a partial deduction may exist. Due to the complexity of the topic, we will simply mention this in passing, but will not discuss it further or include examples because such material will be covered in future articles. Here’s an additional hint, however: determining whether the partial deduction exists also requires consideration of the amount of wages and cost basis of property used in the trade or business.
The proposed regulations provide a de minimis rule – if a trade or business’s SSTB receipts are less than ten percent (10%) of the gross receipts of the trade or business, then the trade or business is not an SSTB, so long as the overall gross receipts of the business are less than $25 million for the taxable year. For those with gross receipts greater than $25 million, the trade or business is not an SSTB so long as not more than five percent (5%) of the gross receipts of the business are from SSTB. This safe harbor provides some assurance to businesses that may be on the fence as to whether they are SSTBs.
The proposed regulations close an opportunity that Congress left open in the Code – separating activities out from SSTBs into non-SSTB trades or businesses. The proposed regulations provide that if a trade or business provides eighty percent (80%) or more of its property or services to an SSTB, and there is fifty percent (50%) or more common ownership of the trades or businesses, then the entire business is also considered an SSTB. Likewise, if there is the same amount of common ownership (50%) but the trade or business provides less than eighty percent (80%) of all of its property or services to the commonly-owned SSTB, then that portion is treated as part of the SSTB. In determining whether the fifty percent (50%) of common ownership test is met, the familiar section 267(b) and 707(b) rules of attribution apply.
A couple examples will help to clarify the meaning of these proposed regulations:
Example #1: Taxpayer is a married-filing-jointly taxpayer who is the sole owner an SSTB. Taxpayer owns and operates a rental business, as well. The rental business only rents to Taxpayer’s SSTB. Because more than eighty percent (80%) of the rental business’s gross receipts come from a related SSTB, the rental business is also an SSTB, and none of its income is eligible for the QBID.
Example #2: The same facts shown in Example #1 apply, except that only thirty percent (30%) of the rental business’s gross receipts are from a commonly-owned SSTB. Thirty percent (30%) of the rental business is treated as part of the commonly-owned SSTB, and is not eligible for the QBID. Taxpayer may claim the QBID for only the remaining seventy percent (70%) of the rental business.
After all of that build-up, we can finally discuss what an SSTB is, and how to possibly avoid the SSTB in some circumstances. Congress provided the following definition for a “specified service trade or business” in new section 199A(d)(2):
Any trade or business which either:
- Is described in section 1202(e)(3)(A) (but ignoring the terms “engineering or architecture”), or which would be described if the term “employees or owners” were substituted for “employees” therein; or
- Which involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as described in section 475(e)(2)).
The second type is new. The first type is not – Congress incorporated an existing provision into the SSTB exception. What is section 1202, and why does it apply to SSTBs, you ask? A brief history lesson provides the answer.
Congress added section 1202 to the Code in 1993. Section 1202 provides an exclusion for up to fifty percent (50%) of a taxpayer’s capital gain from the sale of qualified small business stock, which is stock of certain type of businesses held for more than five years. This sounds wonderful, you say, until we review section 1(h)(4) and determine that the remaining section 1202 gain is subject to tax at a 28% rate and after applying the 50% reduction, the entire gain is subject to tax at a 14% rate. The reductions in the capital gains rates have, for the most part, relegated section 1202 to the statutory scrap heap, due to the slight (or non-existent benefit) for most taxpayers.
Certain trades or businesses have never been eligible for section 1202 gain exclusion. Those trades or businesses are specified in section 1202(e)(3). But this isn’t an article on section 1202 gain, this article is about section 199A. Congress, however, in enacting section 199A didn’t prevent every trade or business that was prevented from claiming section 1202 gain benefits from obtaining the benefits of the new QBID. So, farmers, hotel, motel, restaurant businesses and others who were left out of the section 1202 party can now celebrate with the rest of the section 199A winners.
By referring only to section 1202(e)(3)(A), Congress excluded the following trades or businesses from the QBID (if their income was above the thresholds previously discussed):
“any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”
Given the foregoing definition, we can now see how the proposed regulations provide some real-world clarity as to who will not benefit from the new QBID. The regulations expand upon the text found in the above-quoted paragraph, as it relates to each field.
The proposed regulations provide that “the performance of services in the field of health” means the providing of medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists and other similar health care professionals performing services who provide medical services directly to a patient. Notice that the definition is not as broad as the term “health,” however – the regulations exclude from the reach of SSTB those who operated health clubs, or health spas that provide physical exercise or conditioning to their customers, payment processing, or the research, testing, and manufacture and / or sales of pharmaceuticals or medical devices. Any other service that does not “directly relate to a medical services field” is not an SSTB and is eligible for the QBID.
The “performance of services in the field of law” is defined in the proposed regulations as “the performance of services by individuals such as lawyers, paralegals, legal arbitrators, mediators, and similar professionals performing services in their capacity as such.” Not caught in the SSTB trap are printers, delivery services, or stenography services. As such, court reporters who own all or a portion of their business may look forward to the QBID.
Accountants are subject to the SSTB exception. “Performance of services in the field of accounting” is defined in the regulations as “the performance of services by individuals such as accountants, enrolled agents, return preparers, financial auditors, and similar professionals performing services in their capacity as such.”
The Treasury Department didn’t have much to say about “services performed in the field of actuarial science” other than to refer to “actuaries and similar professionals serving in their capacity as such” as those persons who are included in the scope of the SSTB exception.
“Services performed in the field of performing arts” is defined in the proposed regulations as “the performance by individuals who participate in the creation of performing arts, such as actors, singers, musicians, entertainers, directors, and similar professionals performing services in their capacity as such.” Sorry Willie Nelson and Brad Pitt, no QBID for you.
That definition does not include “the provision of services that do not require skills unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities for use in the performing arts.” It also does not include “the performance of services who broadcast or otherwise disseminate video or audio of performing arts to the public.” Those trades or businesses are winners under the new tax law.
Next, the proposed regulations provide guidance to those who are engaged in the performance of services in the field of “consulting.” Losers under the QBID include those who provide “professional advice and counsel to clients to assist the client in achieving goals and solving problems.” This includes those engaged in advocacy seeking to influence government or governmental officials. Lobbyists with income above the thresholds will not benefit from the QBID.
Those who are not deemed “consultants” for purposes of the QBID are those who “perform services other than advice and counsel, such as sales or economically similar services or the provision of training and educational courses.” Such persons are eligible for the QBID, potentially.
What determines whether one’s services are “sales or economically similar services?” The proposed regulations fall back to the familiar “all the facts and circumstances” test to make the call. Most important, however, is the way that the business is compensated for the services provided. If the services are “embedded in, or ancillary to, the sale of goods or performance of services on behalf of a business that is not an SSTB” and there is no separate payment for consulting services, you fall outside the scope of SSTB.
Here, Treasury is looking down to the invoice level, and so should businesses wishing to maximize their QBID. For various reasons, including sales tax reasons, businesses will often separate consulting services on invoices. This should not be done without good reason. If a business can legitimately include the consulting services within the sale of goods or non-SSTB services, the business should. This will maximize the QBID.
Sorry, Lebron James, if you are reading this article, you are a QBID loser. “Performance in the field of athletics” includes the “performance of services by individuals who participate in athletic competition such as athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing.”
Those persons who provide maintenance and operation of equipment or facilities for use in athletic events, and those persons who provide services involved in broadcasting or otherwise disseminating video or audio of athletic events to the public are winners in the SSTB lottery, just as similar persons engaged in such services related to the performing arts would be.
Losers under the QBID are those who “perform services in the field of financial services.” These include those who provide financial services including “managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including bankruptcy or similar cases), raising financial capital by underwriting, or acting as a client’s agent in the issuance of securities and similar services.” Among the specifically-named professions include financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals performing services in their capacity as such.
QBID losers include those who “perform services in the field of brokerage services” including stock brokers and other similar professionals. They fall within the definition of “services in which a person arranges transactions between a buyer and a seller with respect to securities for a commission or a fee.”
QBID winners include real estate agents and brokers, and insurance agents and brokers. Make that next sale confident that Congress wants you to have that QBID, as you are not “performing services in the field of brokerage services.”
The proposed regulations also provide that “the provision of services in investing and investment management” refers to “a trade or business involving the receipt of fees for providing investing, asset management, or investment management services, including providing advice with respect to buying and selling investments.” As such, income received from these services are not eligible for the QBID deduction. This term does not include those services involved in directly managing real property, so the real estate industry picks up another QBID win.
The meaning of the term “provision of services in trading” means “a trade or business of trading in securities, commodities, or partnership interests.” Again, this definition is likely to be determined by courts as it depends upon “all the facts and circumstances.” The important facts include the source and type of profit associated with engaging in that activity. The proposed regulations create an exception for manufacturers and farmers who engage in hedging transactions as part of their trade or business of farming or manufacturing. If you fit into that last category, you are a QBID winner for those services.
In connection with the definition of “a trade or business of trading in securities, commodities, or partnership interests,” the definition of trading in securities means “regularly purchasing securities from and selling securities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business.” Commodity traders and dealers in partnership interests are governed by similar provisions for their respective trades or businesses and are losers in the QBID lottery.
If you have read through the categories and don’t see your trade or business, don’t get too comfortable yet. The Code and proposed regulations provide for a catch-all for “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners” means any trade or business that meets any of the following criteria:
- A trade or business where the person receives fees, compensation, or other income for endorsing products or services. Once again, sorry Lebron James, if you thought you could get a QBID for your Nike sponsorship income, you are sadly mistaken.
- A trade or business in which a person licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity.
- Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
For purposes of determine what is “fees, compensation, or other income” the proposed regulations provide that such definition includes any partnership interest or S corporation stock, and the corresponding distributive share of income, deduction, gain or loss from the partnership interest or S corporation stock.
Those readers who are engineers and architects who have suffered through the length of this article can finally move back from the edge of their seats, as it is clear that the exclusion of the definition of architects and engineers from SSTB by category excludes you, as the definition of “trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners” would not pertain to architects and engineers. Unless, of course, you decide to display your talents on a reality show.
People engaged in “specified service trades or businesses” are the losers under the new qualified business income deduction, unless their income is below the thresholds. Here, we have addressed the proposed regulations with the goal of providing a greater understanding of who qualifies for the QBID, and who doesn’t. Please contact your CSH advisor for more information on QBID and to discuss if you’re eligible.