There’s been “much ado” about the creation of the new 20% tax deduction for “Qualified Business Income” (QBI) in the Tax Cuts and Jobs Act of 2017. Although the deduction “tax relief” for small businesses (pass-through entities) in order to free up more funds to help them grow and create more jobs, high-income professions which generate profits directly from their owner’s skills and talent (think doctors, lawyers, accountants, entertainers) were classified as “specified service trades or businesses” (SSTB) and essentially excluded from the QBI deduction.
While most middle-class business owners will qualify for the deduction based on their income (up to $157,000 for individual filers and up to $315,000 for married couples filing joint returns), the exclusion from the QBI deduction is aimed at high-income earners classified as a “service business,” generating taxable income above those specified thresholds. The Legislative Text of IRC Section 199A states a Specified Service Trade or Business would include:
“…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.”
Due to the broad definition, questions immediately arose.
-Are pharmacists, medical technicians or veterinarians treating non-human patients regarded as SSTB’s in the healthcare industry?
-If a business provides widespread services such as “tax preparation” or “insurance products,” is that considered a product or skill?
-What is the classification for a business offering a vast array of skilled services?
-Does a business that provides “a specialized service” and sells products to generate income qualify for QBI?
Just a few examples of the many questions that have surfaced, it’s no wonder the issuance of proposed regulations on the Qualified Business Income Deduction (IRC Section 199A) by the IRS was highly-anticipated by tax professionals and business owners alike. Issued on August 8, 2018, they provide much-needed direction to determine what businesses should be classified as a Specified Service Trades or Business and excluded from the QBI Deduction. Following are some of the highlights.
Specific information regarding the healthcare and financial industries provides clarification on which skilled professionals should be considered as SSTBs.
Multi-purpose and blended businesses are also addressed. The proposed regulations do not allow a single business to separate non-SSTB profits from SSTB profits. The entire business is either a non-SSTB that could qualify for a QBI Deduction (under income thresholds) or an SSTB entity that does not qualify.
One of the most notable proposals is the 80/50 Spin-Off rule which aims to prevent a tax strategy (commonly known as crack and pack) that spins off portions of an SSTB into a separate entity or investment in order to shift income. (think a doctor buying real estate then renting it back to himself or herself as office space.) Basically, if a business has 50% or more common ownership with an SSTB which provides 80% or more of its services to the business, by regulation, it will be regarded as an SSTB in its entirety.
For high-income small business owners engaged in some type of specified services with income over QBI thresholds, the new SSTB rules require careful planning in order to avoid pitfalls when planning tax strategies.
At Tax Savings Professionals, we have worked with thousands of clients over the past 18 years and can answer any questions you may have about the QBI Deduction, SSTB status or any other tax issue. Give us a call at (772) 257-7888 or click on our contact form today.