Specified Services and the QBI Deduction October 3, 2018
IRS NEWS — on Specified Services and the QBI Deduction (PR §1.199A-5)
An individual with “specified service” income cannot benefit from the new Qualified Business Income (QBI) deduction if the individual has taxable income in excess of a threshold. Therefore, those in a specified service trade or business who have taxable income above $157,500 ($315,000 MFJ) are subject to a phase-out of their QBI deduction and at taxable income of $207,500 ($415,000 MFJ), they cannot claim any QBI deduction.
Example. Mary, a single taxpayer with taxable income below the threshold, has net schedule C income from her specified service business of $50,000. She is entitled to a $10,000 QBI deduction1. If Mary has taxable income above $207,500, she cannot claim any QBI deduction. For Mary, the important question is “what is a specified service business?”
What is a specified service business? IRS released 184 pages of proposed regulations on August 8, 2018 explaining the new qualified business income (QBI) deduction. The regulations provide some answers to Mary’s question. A specified service trade or business (SSTB) is defined in§199A(d)(2) and proposed §1.199A-5 2.
Important. The definition of a specified service trade or business is only important for individuals that have taxable income above the threshold amounts. If an individual has taxable income below the threshold amount, the individual is eligible to receive the 20% QBI deduction, notwithstanding that a trade or business is an SSTB (Q7).
A “specified service trade or business” includes personal-service-type trades or businesses involved in the following performance of services:
- health,
- law,
engineering,architecture,- accounting,
- actuarial science,
- performing arts,
- consulting,
- athletics,
- financial services,
- brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities (for this purpose a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (§475(c)(2) and §475(e)(2)), and
- Any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees (§199A(d)(2)).
What are health services? “Performance of services in the field of health” means the provision of medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals who provide medical services directly to a patient. The performance of services in the field of health does not include the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient (PR §1.199A-5(b)(2)(ii)).
What is included in the field of law? The“performance of services in the field of law” means the provision of services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals in their capacity as such but does not include the provision of services that do not require skills unique to the field of law (PR §1.199A-5(b)(2)(iii)).
What is included in the practice of accounting? The term “performance of services in the field of accounting” means the provision of services by accountants, enrolled agents, return preparers, financial auditors, and similar professionals in their capacity as such. Provision of services in the field of accounting is not limited to services requiring state licensure as a CPA. Accounting services include tax return and bookkeeping services, even though the provision of such services may not require the same education, training, or mastery of accounting principles as a CPA. (PR §1.199A5(b)(2)(iv)).
Tax practitioner planning. The field of accounting does not include payment processing and billing analysis. (PR §1.199A-5(b)(2)(iv)).
Why are engineering and architectural services excluded? Engineering and architectural services are excluded from specified services in a manner similar to old §199, the domestic production activity deduction.
What is included in actuarial science? “Performance of services in the field of actuarial science” means the provision of services by actuaries and similar professionals (PR §1.199A-5(b)(2)(v)).
Tax practitioner planning. The field of actuarial science does not include the provision of services by analysts, economists, mathematicians, and statisticians not engaged in analyzing or assessing the financial costs of risk or uncertainty of events (PR §1.199A-5(b)(2)(v)).
What is included in performing arts? “Performance of services in the field of the performing arts” means the services performed 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 (PR §1.199A-5(b)(2)(vi)).
Tax practitioner planning. The performance of services in the field of performing arts does not the maintenance and operation of equipment or facilities for use in the performing arts nor does it include the services by persons who broadcast or otherwise disseminate video or audio of performing arts to the public (PR §1.199A-5(b)(2)(vi)).
What is included in consulting services? “Performance of services in the field of consulting” means the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems. Consulting includes providing advice and counsel regarding advocacy with the intention of influencing decisions made by a government or governmental agency and all attempts to influence legislators and other government officials on behalf of a client by lobbyists and other similar professionals performing services in their capacity as such (PR§1.199A-5(b)(2)(vii)).
What happened if the sale of products includes the services of consulting? A de minimis bright-line protection! In certain kinds of sales transactions it is common for businesses to provide consulting services in connection with the purchase of goods by customers. The de minimis rule, under which a trade or business is not an SSTB, is allowed if less than 10% of the gross receipts (5% if the gross receipts are greater than $25 million) are attributable to the performance of services in a specified service activity (PR §1.199A-5(c); PR §1.199A-5(b)(2)(vii)).
Example. A company that sells computers may provide customers with consulting services relating to the setup, operation, and repair of the computers, or a contractor who remodels homes may provide consulting prior to remodeling a kitchen. §1.199A-5(c) provides a de minimis rule, under which a trade or business is not an SSTB to take into consideration businesses that provide incidental consulting services.
Tax practitioner planning. The field of consulting does not include consulting that is embedded in, or ancillary to, the sale of goods if there is no separate payment for the consulting services (PR §1.199A-5(b)(2)(vii)).
What is included in athletics? Being similar to the field of performing arts, “performance of services in the field of athletics” means 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 (PR §1.199A-5(b)(2)(viii)).
Tax practitioner planning. The performance of services in the field of athletics does not include the maintenance and operation of equipment orfacilities for use in athletic events nor does it include services by persons who broadcast or otherwise disseminate video or audio of athletic events to the public (PR §1.199A-5(b)(2)(viii)).
What is included in financial services? The definition of financial services is limited to services typically performed by financial advisors and investment bankers. This includes 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 in title 11 or similar cases), and raising financial capital by underwriting, or acting as the client’s agent in the issuance of securities, and similar services. It also includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals, but it does not include taking deposits or making loans (PR §1.199A-5(b)(2)(ix)).
What is included in brokerage services? Brokerage services include investing and investment management, trading, or dealingin securities, partnership interests, or commodities for a commission or fee such as services provided by stock brokers and other similar professionals (PR §1.199A-5(b)(2)(x)). The performance of services that consist of investing and investment management includes either a commission, a flat fee, or an investment management fee calculated as a percentage of assets under management (PR §1.199A-5(b)(2)(xi)).
Tax practitioner planning. Brokerage services do not include services provided by real estate agents and brokers, or insurance agents and brokers (PR §1.199A-5(b)(2)(x)).
Tax practitioner planning. The performance of services of investing and investment management does not include directly managing real property (PR §1.199A-5(b)(2)(xi)).
What is included in “reputation and skill’? 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 is an SSTB.
The big question. Any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees is an SSTB. When is the “skill and reputation” of an owner or employee considered the principal asset of the business? Is it a Realtor in the business of selling houses? A Hollywood interior designer? A Broadway award winning costume designer?
The meaning of the “reputation or skill” clause is limited to fact patterns in which the individual or relevant passthrough entity (RPE) is engaged in the trade or business of:
1. Endorsements. Receiving income for endorsing products or services, including an individual’s distributive share of income or distributions from an RPE for which the individual provides endorsement services;
2. Licensing individual’s identity. Licensing or receiving income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity, including an individual’s distributive share of income or distributions from an RPE to which an individual contributes the rights to use the individual’s image; or
3. Appearance fees. Receiving appearance fees or income (including fees or income to reality performers performing as themselves on television, social media, or other forums, radio, television, and other media hosts, and video game players) [PR §1.199A-5(b)(2)(xiv)].
Example. Wolfgang Puck is a well-known chef and the sole owner of multiple restaurants each of which is owned in a disregarded entity. Due to Wolfgang Puck’s skill and reputation as a chef, Wolfgang Puck receives an endorsement fee of $500,000 for the use of Wolfgang Puck’s name on a line of cooking utensils and cookware. Wolfgang Puck is in the trade or business of being a chef and owning restaurants and such trade or business is not an SSTB. However, Wolfgang Puck is also in the trade or business of receiving endorsement income. Wolfgang Puck’s trade or business consisting of the receipt of the endorsement fee for Wolfgang Puck’s skill and/or reputation is an SSTB within the meaning of PR §1.199A-5 (b)(1)(xiii) and (b)(2)(xiv) (Ex. 8).
Example. Cameron Diaz is a well-known actor. Diaz entered into a partnership with TAGHeuer, in which DeGeneres contributed her likeness and the use of her name to the partnership in exchange for a 50% interest in the capital and profits of the partnership and a guaranteed payment. Diaz’s trade or business consisting of the receipt of the partnership interest and the corresponding distributive share with respect to the partnership interest for Diaz’s likeness and the use of her name is an SSTB within the meaning of PR §1.199A-5 (b)(1)(xiii) and (b)(2)(xiv) (Ex. 9). Of course, her income as an actor is also from an SSTB.
SSTB Is Determined at Entity Level, Not Ownership Level
In the case of an SSTB conducted by an entity, such as a partnership or an S corporation, if it is determined that the trade or business is an SSTB, none of the income from that trade or business flowing to an owner of the entity is QBI, regardless of whether the owner participates in the specified service activity. A direct or indirect owner of a trade or business engaged in an SSTB is treated as engaged in the SSTB regardless of whether the owner is passive or participated in the SSTB. Said another way, if a partnership or an S corporation operates an SSTB, the application of the threshold does not depend on the partnership or S corporation’s taxable income but rather the taxable income of the individual partner or shareholder claiming the 20% QBI deduction (PR §1.199A-5).
Example. If the partnership’s taxable income is less than the threshold amount, but each of the partnership’s individual partners have income that exceeds the threshold amount $157,500 -$207,500 ($315,000 -$415,000 in the case of a joint return) then none of the partners may claim a 20% QBI deduction with respect to any income from the partnership’s SSTB (PR §1.199A-5).
Example: If a partnership owns a professional sports team, the partners’ distributive shares of income from the partnership’s athletics trade or business is not QBI, regardless of whether the partners participate in the partnership’s trade or business (PR§1.199A-5).
De Minimis Rule
A trade or business is not an SSTB if the trade or business has gross receipts of $25 million or less (in a taxable year) and less than 10% of the gross receipts of the trade or business is attributable to the performance of services in an SSTB. For trades or business with gross receipts greater than $25 million (in a taxable year), a trade or business is not an SSTB if less than 5% of the gross receipts of the trade or business are attributable to the performance of services in an SSTB (§1.199A-6(b)(3)(B); §1.199A-5(c)(1)).1 If Mary’s taxable income is less than her QBI of $50,000, she is limited to 20% of her taxable income.
2 The definition of an SSTB in §199A incorporates, with modifications, the text of §1202(e)(3)(A) which relates to the small business stock exclusion and §448 which relates to personal service corporations.