Is My Business A Specified Service Trade Or Business
Executive Summary
While much of the Taxation Cuts and Jobs Act of 2017 was focused on individual and corporate tax reform and simplification, 1 of the biggest new planning opportunities that emerged was the creation of a new twenty% tax deduction for "Qualified Business organisation Income" (QBI) of a pass-through entity, intended to provide a tax benefaction to small-scale businesses that would leave more profits with the business to assist it grow and hire.
The caveat, still, is that the QBI deduction was only intended to provide taxation benefits for profitable businesses that hire employees, not to provide tax benefits for loftier-income professions who generate their profits directly from their own personal labors. Equally a result, the new IRC Section 199A created a so-chosen "Specified Service Concern" classification that, at higher income levels, would not be eligible for the QBI deduction.
The challenge, nevertheless, is that the verbal definition of what constitutes a "Specified Service Merchandise or Business" (SSTB) has not always clear, given the wide range of professional services that be in the marketplace. In addition, as soon as the rules themselves were released, creative revenue enhancement planners began to strategize nigh how to adjust (or re-arrange) revenue and profits to maximize the amount of income eligible for the QBI deduction and minimize exposure to the Specified Service Business rules.
In this guest mail, Jeffrey Levine of BluePrint Wealth Alliance, and our Manager of Advisor Education for Kitces.com, examines the latest IRS Proposed Regulations for Section 199A, which provides both important clarity to how the "Specified Service Business" test volition apply in various industries, including rather broadly for professions like wellness, law, and bookkeeping, but but narrowly to high-profile celebrities who may accept their endorsements and paid appearances treated as specified service income but non the income from their other businesses that may all the same materially benefit from their high-profile reputation.
Of greater significance for many small business concern owners, though, are new rules that will force businesses with fifty-fifty but minor specified service income to care for the entire entity equally an SSTB, limit the ability of specified service businesses to "carve off" their non-SSTB income into a dissever entity, and in many cases aggregate together multiple commonly endemic SSTB and non-SSTB concern for tax purposes.
Ultimately, the new rules are only impactful for the subset of small business owners who engage in specified service business organization activities and have enough taxable income to exceed the thresholds where the phaseout of the QBI deduction begins (which is $157,500 for individuals and $315,000 for married couples). Nonetheless, for that subset of high-income business organization owners, constructive planning to avoid having SSTBs "taint" not-SSTB income, or to split off non-SSTB income to the extent possible, will exist more than challenging than before.
IRS Issues Proposed Regulations i.199A On The Qualified Business Income Deduction
On August 8, 2018, the IRS released the much-predictable proposed regulations for IRC Section 199A. The regulations provide a veritable treasure-trove of information, and in item, articulate up many of the questions surrounding Specified Service Trade or Businesses (SSTB). Most importantly, they provide much-needed clarity to decide exactly what businesses should exist classified every bit an SSTB (or not). This determination is of minimal importance to low and moderate income earners (upward to $315,000 for married couples filing joint returns, and up to $157,500 for all other filers), but is critical to high earners above those thresholds, who may meet their qualified business organization income (QBI) deductions related to specified service trade or businesses partially or fully phased out as their income exceeds those thresholds.
Understanding The Definition Of A Specified Service Trade Or Business (SSTB)
The principal purpose of the IRC Section 199A deduction for Qualified Business Income (QBI) was to provide a revenue enhancement benefaction for businesses that hire and utilise people to grow the US economy, but not to requite a deduction to those who merely earned a substantial income from the fruits of their own labor. Not that all service businesses would exist prohibited… just specifically the ones that generated income primarily by providing diverse types of professional services.
Accordingly, IRC Department 199A defines sure "SpecifiedService Merchandise or Businesses" (SSTBs) that, at higher income levels, are not eligible for the QBI deduction. Cartoon on IRC Section 1202(e)(3)(A) (which defines eligibility for certain types of pocket-sized business stock capital gains to exist excluded from income, and similarly is not available for professional services firms), the legislative text of IRC Section 199A stipulated that an SSTB would include:
"…whatever trade or business involving the performance of services in the fields of wellness, law, bookkeeping, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or whatsoever trade or business where the principal nugget of such merchandise or business is the reputation or skill of 1 or more of its employees."
(Notably, IRC Section 1202(e)(3)(A) also includes engineers and architects, but those professions were explicitly excluded from the list of SSTB professions under IRC Section 199A(d)(2)(A).)
In addition to the businesses listed above, IRC Section 199A(d)(2)(B) adds the following businesses to the list of SSTBs:
"…whatever trade or business organization which involves the functioning of services that consist of investing and investment management, trading, or dealing in securities."
While some of these professions are relatively straightforward to define, the original legislative text for Section 199A left much up to estimation when determining whether or non certain businesses would exist treated as a specified service trade or business organisation (SSTB), both with respect to certain border cases within professions (east.thousand., does an auditor who only does tax preparation but non business organisation accounting and auditing still "count" equally accounting services, and does income from selling insurance products count as "financial services" or simply providing investment communication?), and the relatively broad catch-all at the terminate of the SSTB list for "any trade or business where the main asset of such trade or business concern is the reputation or skill of 1 or more of its employees" (raising the question of whether a eating place qualifies for the QBI deduction, but a restaurant with a star chef might not?).
Clarifying The Scope Of Professions That Are "Specified" Service Businesses
Fortunately, the new IRC Section 199A regulations provide a great deal of clarity about where, exactly, to draw the line betwixt the 13 dissimilar types of specified service businesses and all other types of service businesses.
Some types of SSTBs are relatively straightforward and required minimal clarification from the IRS, such as athletics and performing arts. The regulations do, yet, clarify that persons engaged in supporting services, such as those who maintain or operate equipment or facilities for such businesses, are not SSTBs, themselves.
Determining what types of and roles within diverse professional service occupations fall into – and just as important, do not autumn into – the other SSTB categories was less articulate from the original legislation, though, and thus required more than specific guidance from the IRS in the regulations.
Health, Law, and Accounting Services Are Defined Broadly For Specified Service Trade Or Business organization
Given that the healthcare sector is now the largest employer in the Us economy, "Wellness" services was one area where there were a number of open questions about the scope of the specified service rules. For instance, while information technology'south relatively straightforward that doctors are in the health profession… it was less clear whether pharmacists and similar 'related' healthcare professionals would be included in the definition, as well every bit veterinarians and others providing "healthcare" to non-humans. The proposed regulations have an inclusive arroyo here and make clear that both pharmacists and veterinarians are considered health services, and thus, are SSTBs. Accordingly, the newly proposed regulations stipulate that:
"…the performance of services in the field of health means the provision of medical services by individuals such equally physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists and other like healthcare professionals performing services in their chapters equally such who provide medical services straight to a patient (service recipient)."
The proposed regulations also accept a similarly inclusive approach with respect to the fields of "bookkeeping" and "law." As a consequence, the one-time includes not but "accountants," but also "enrolled agents, return preparers, financial auditors, and similar professionals," while the latter too includes "paralegals, legal arbitrators, mediators, and similar professionals" in add-on to lawyers, themselves.
Non All Financial Services Are Treated As SSTB Fiscal Services
Of particular importance to financial professionals, five of the 13categories of SSTBs direct chronicle to various professions within the financial industry (financial services, brokerage services, investing and investment management, trading and dealing in securities, partnerships or commodities), while two more than could chronicle indirectly (consulting and the "primary asset is the skill or reputation of one or more than employees"). Thus, many high-income owners of financial services businesses will be considered owners of an SSTB and volition brainstorm to run across their QBI deduction stage out once their income exceeds their applicative threshold.
Some of the fiscal services professions explicitly "called out" in the proposed regulations every bit unequivocally existence SSTBs include "financial advisors, investment bankers, wealth planners, and retirement advisors," as well equally those "receiving fees for investing, asset management, or investment management services, including providing communication with respect to buying and selling investments." Businesses engaged in either the trading or dealing of securities, commodities, or partnership interests are also SSTBs, equally are brokers of securities (i.e., registered representatives of a banker-dealer).
While most financial services professionals are engaged in SSTBs, the regulations do exclude real estate agents and brokers from the definition of an SSTB likewise. More importantly, though, the regulations also grant two other very notable exceptions to the dominion: traditional bankers (not investment bankers), and insurance agents or brokers. Is this just because they accept better lobbyists than the rest of the financial industry? Perhaps that played at least some role, simply the crux of the outcome tin can exist traced dorsum to the initial legislative text creating the QBI deduction.
As noted earlier, under IRC Department 199A(d)(2)(A), an SSTB is any business described in IRC Department 1202(eastward)(three)(A), other than engineers and architects (who plain likewise have very good lobbyists!), including:
"…whatsoever trade or business involving the performance of services in the fields of health, law, bookkeeping, actuarial science, performing arts, consulting, athletics, fiscal services, brokerage services, or any trade or business where the principal asset of such merchandise or business concern is the reputation or skill of 1 or more of its employees."
Conspicuously absent from the listing of businesses above are banking and insurance. Notably, these businesses are included in the following subparagraph of the IRC, IRC Section 1202(e)(3)(B), which states:
"any banking, insurance, financing, leasing, investing, or similar business"
Notwithstanding, when Congress wrote the law defining what constitutes an SSTB, it explicitly stated only the professions under IRC Section 1202(e)(iii)(A) – and not IRC Section 1202(e)(3)(B) – would count. Appropriately, the IRS determined in its proposed regulations that a more narrow interpretation of "financial services" (one that does non include traditional cyberbanking or insurance services) was advisable. After all, if Congress wanted to include those businesses in the definition of SSTBs, they could have referenced both IRC Section 1202(east)(three)(A) and IRC Department 1202(east)(3)(B) when it created IRC Section 199A. Its failure to practise so provided the IRS with enough legislative intent that they explicitly excluded those businesses from the definition of an SSTB in the regulations.
As a result of the divergence between the way qualified business income from financial planning/securities brokerage/investment advice is treated as compared to qualified business income from insurance services, many registered investment advisors and/or securities brokers who also acquit insurance concern volition find that the profits from their different businesses will be treated markedly dissimilar from 1 another. While profits from the fiscal planning/securities brokerage/investment advice business concern(es) will be potentially ineligible for the QBI deduction once the possessor'southward taxable income exceeds $207,500, or $415,000 if married and filing a joint return, profits from the insurance business organization may yet eligible for the deduction as a non-SSTB (though computing the deduction would still involve analyzing the West-2 wages paid by the insurance business, as well as whatever depreciable property endemic past the business organisation, under the separate wage-and-holding examination for the QBI deduction).
Unfortunately, though, information technology is not uncommon for certain advisors, particularly solo-advisors, to run both their brokerage/advisory revenue and their insurance revenue through the aforementioned "financial advisor" sole-proprietorship. In the by, this frequently made sense, as treating the brokerage/informational business equally a carve up business from the insurance-related business concern would generally lead to unnecessary complication and expense, both from the requirement to keep two sets of books, as well equally the need to file multiple Form Schedule Cs (or other concern returns) with the advisor's personal income tax return.
Now, even so, in light of the proposed regulations' differentiation between the profits of the two businesses, high-income advisors may wish to more clearly split and delineate these different "lines of business" into two, distinct businesses. If not, the proposed regulations' de minimis dominion, discussed in greater depth beneath, could "taint" any insurance services profits that would otherwise be eligible for the QBI deduction.
When the legislative text for IRC Section 199A was created, one of the about nebulous aspects of the definition of an SSTB was the catch-all provision that, "any trade or business where the principal asset of such merchandise or business is the reputation or skill of 1 or more than of its employees," is an SSTB. How would the IRS determine whether an employee or business owner's "skill or reputation" was the driving forcefulness behind the business's profits? Rightfully so, many practitioners were concerned that this language could ensnare just about any business organisation with a successful and loftier-profile founder/owner.
For example, "January'due south Furniture Shop" probably doesn't fall into the category of an SSTB. But what if Jan was highly regarded as the most skilled article of furniture maker in town, and her reputation equally a skilled craftsman was what drove sales? Exactly how skilled or respected would Jan have to be before the business crossed over from a non-SSTB to an SSTB? Similarly, "Bob'southward Diner" probably isn't an SSTB, simply what if "Bob" was really famous chef Bobby Flay? Clearly, such an assay is highly subjective at best, which was a principal driver of many practitioners' concerns.
Thankfully, these concerns are no longer necessary. In what was a relatively surprising move, the IRS defined the meaning of a merchandise or business organisation where the chief asset of that business is the reputation or skill of one or more than employees or owners in, perhaps, the narrowest of possible ways.
Co-ordinate to the proposed regulations, a business is only considered an SSTB by virtue of the "reputation or skill" provision if, and just if, information technology generates fees, compensation, or other income via one or more of the following:
- Endorsements of products or services;
- Utilize of an individual's image, likeness, name, signature, voice, trademark, or whatever other symbol associated with the individual's identity;
- Appearances on radio, television, or other media.
Equally a outcome of the IRS'south extremely narrow interpretation of the "reputation or skill" provision in the 199A regulations, the provision has gone from potentially beingness 1 of the primary culprits of classifying a business as an SSTB, to existence fairly benign, and applicable only to an extremely express number of "businesses" that are truly built around "celebrity" endorsements, appearances, and the like.
In fact, the proposed regulations include a number of IRS-provided examples, and Example eight of Section 199A-five(b)(3) of the regulations provide possibly the all-time insight as to how narrowly the IRS has framed this "reputation or skill" provision.
H is a well-known chef and the sole owner of multiple restaurants, each of which is owned in a disregarded entity. Due to H's skill and reputation as a chef, H receives an endorsement fee of $500,000 for the use of H'south name on a line of cooking utensils and cookware. H is in the trade or business of being a chef, and owning restaurants and such trade or business is not an SSTB. Withal, H is likewise in the trade or business of receiving endorsement income. H'due south trade or business consisting of the receipt of the endorsement fee for H'southward skill and/or reputation is an SSTB inside the significant of paragraphs (b)(ane)(xiii) and (b)(2)(xiv) of this department.
If the chef in the example higher up is able to receive an endorsement fee of $500,000 for the employ of their proper name on a line of cooking utensils and cookware, it'south probably pretty condom to assume that they are not simply a pretty good chef (i.east., they are skilled) only that they are also fairly well known (i.due east., has a strong reputation). Every bit such, 2 of the main drivers of the chef's restaurants revenues are likely the chef'south skill and reputation. And withal, in the example, the IRS makes clear that these restaurants would not be considered SSTBs, as they do not meet the (favorably) rigid definition of the "reputation or skill" provision outlined above, despite the fact that they are probable successful at least in material part to the "reputation or skill" of their celebrity chef-owner.
Many businesses appoint in more than one specific activity or business line at a time, creating a potential challenge to determine whether or not the concern, as a whole, is an SSTB. In some cases, this is ostensibly easier because the business lines are literally separated into discreet divide entities, for liability protection and/or other purposes (even though they're still "related" entities). Though in the extreme, separating businesses into discrete entities as well creates the concerning potential (at least for the IRS) that firms will carve off what otherwise would accept been SSTB profits (not eligible for the QBI deduction) into separate entities that would qualify (even though in the aggregate it shouldn't take).
Accordingly, the proposed regulations provide guidance on how to deal with both circumstances, both with respect to determining when the SSTB revenue in an otherwise non-SSTB business must exist treated every bit such, and when and whether to amass back together separate-just-related SSTB and non-SSTB entities into 1 SSTB.
Application of the "De Minimis Rule" In Determining A Specified Service Merchandise or Business
Often, a single business will simultaneously conduct multiple business activities. In some situations, i or more than of those discrete activities, if conducted by a separate business concern, would cause that concern to be treated as an SSTB. The proposed regulations exercise non, as some had hoped, allow a unmarried business to separately account for different lines of revenue and expenses and segregate SSTB profits vs. not-SSTB profits. Instead, the entire concern is either an SSTB… or it'south not. As such, either all of the profits of a business organization are profits of an SSTB entity, or all of the profits are profits of a non-SSTB.
This raises an obvious question… how much revenue tin a unmarried business generate from an activeness that would be considered an SSTB if conducted in its ain, separate business, before the entire business is considered an SSTB? The respond, unfortunately, is "non much."
Under the proposed regulations, if a business organisation has gross revenue of $25 1000000 or less during a taxable yr, and so the business organisation must keep its SSTB-related revenues to less than ten% of its gross revenue to avert SSTB status. Or conversely, the $25M-or-less-acquirement business will be considered an SSTB if just x% or more of its gross revenue is derived from an SSTB-type activity!
In the upshot a concern generates more than $25 million of revenue during a taxable year, the SSTB rules are even more than restrictive. Such businesses volition be considered an SSTB if only 5% or more than of their gross revenue is derived from an SSTB-related activity.
Example #1: Frank is an optometrist, and is the sole owner of Spectacular Glasses, LLC, which is primarily engaged in the manufacturing and sale of eyeglasses (not an SSTB-related activity). Occasionally, however, Frank volition perform (and accuse for) eye examinations, in office, to determine a customer's right prescription. These exams are related to health services, and thus, are an SSTB-related activity.
In 2018, Spectacular Spectacles, LLC generates $3 1000000 of gross acquirement. The $iii million of gross acquirement is comprised of $2,880,000 one thousand thousand of acquirement related to the manufacturing and sales of eyeglasses, with the remaining $120,000 of revenue attributable to Frank'southward occasional vision exams. Since only 4% ($120,000 / $3 million = 4%) of Spectacular Spectacles, LLC's full acquirement is comprised of SSTB-related revenue, the concern will not be considered an SSTB.
Specified Service Revenue Taints Non-SSTBs And The Incidental SSTB Rule
In that location are a number of interesting corollaries to the SSTB de minimis rule. Well-nigh notable is the fact that although it'southward business organization's profits that are eligible for the QBI deduction in the first place, the determination of whether or not a business with acquirement from multiple activities is considered an SSTB is determined solely by the ratio of its acquirement from SSTB activities in relation to its total acquirement. Which is apropos, because it means a high-revenue depression-margin specified service business can taint the QBI deduction for an entire loftier-profit not-SSTB!
Example #2: Bill, one of Spectacular Glasses, LLC's employees, decides to get out and start his own eyeglass manufacturing and sales company, Spectacles for the Masses, LLC. Bill is non a doctor, simply in an endeavor to drive business and compete with his former employer, he hires several optometrists who can perform vision examinations and heavily promotes and advertises this service.
In 2018, Glasses for the Masses, LLC generates $ane.6 million of revenue and $550,000 of profits. Every bit a result of the profits, Nib is over his applicable threshold, and thus, volition exist ineligible for any QBI deduction if his business is deemed an SSTB.
Analyzing Glasses for the Masses, LLC's revenue and profits further, it is determined that $400,000 of the company's total revenue is derived from the heavily marketed heart examinations. Nonetheless, after accounting for expenses, including the salaries of the two optometrists, this action just generates $fifty,000 of profit. In contrast, the cadre business of manufacturing and selling eyeglasses generates $ane.two million of revenue, and $500,000 of profit.
Just about nine% ($fifty,000 /$550,000 = 9.09%) of Glasses for the Masses, LLCs profits are owing to an SSTB-related activity. The entire business, all the same, and all of the profits, volition exist considered an SSTB for 2018 since 25% ($400,000 / $ane.half-dozen meg = 25%) of its revenues are owing to the SSTB-related optometry activity… well more than than the ten%-of-revenue hurdle necessary to wind upwardly with that categorization. The end result? Bill gets $0 of QBI deduction on his $550,000 of profit (most all of which was non-SSTB profit, but all of which was disqualified equally a high-income SSTB business organisation nonetheless!).
For business owners like Bill, there are a couple of different options.
1 option, for case, would exist to merely eliminate the SSTB-related activeness that's not all that assisting in the first identify. Unfortunately, that may exist easier said than done. What if much of Spectacles for the Masses, LLC'south acquirement and profits from the manufacturing and sale of glasses (not-SSTB-related) is due to the fact that customers are able to get an eye test and buy their eyeglasses in ane location (which, in the extreme, could brand it worthwhile to keep the SSTB service that disqualifies the QBI deduction simply because it'due south "necessary" for the business organisation)?
Another option for business owners like Bill is to split the diverse activities into legitimate, bona fide, separate businesses. In such situations, each concern will generally be evaluated on its own merits. Splitting activities into separate businesses in this manner (eastward.g. creating GM Optometry to perform optometry services) might create some operational challenges for Bill, such equally the need for customers getting an eye exam and purchasing glasses to pay two carve up bills to the two separate companies (an eye exam beak to the optometry business and a spectacles bill to Glasses for the Masses, LLC), merely the resulting tax benefits may be worth it. In Neb'south instance, information technology would hateful a 20% revenue enhancement deduction on up to $500,000 of profits… annually!
On the other manus, the proposed regulations do have an additional layer of rules specifically intended to limit splitting off a multitude of small non-SSTBs to insulate them from an SSTB core (which wouldn't be applicative in the example above, but could be an consequence for an optometrist that primarily provided centre exams equally health services and only sold a few eyeglasses "on the side"). Specifically, under the "incidental-to-SSTB" rules, if a not-SSTB has 50%-or-more than common ownership with an SSTB and has shared expenses, it must have revenues of more than 5% of the combined revenues of both businesses, or they will all be aggregated as an SSTB anyhow. Accordingly, in order to be treated as a dissever SSTB (and non taint the non-SSTB cadre), the separate business concern must either have revenues of more than than 5% of the combined entities, or accept its own entirely independent toll structure and not share wages, overhead, or other business concern expenses.
Example #three: Jerry, Spectacular Spectacles, LLC's most popular optometrist, decides to go out on his own every bit an optometrist, and over 3 years quickly grows to generate $500,000/year of revenue. While Jerry's business is solely focused on providing optometry (health services), which is an SSTB, his wife Elaine (an artist) suggests that he beginning selling a pocket-sized number of designer eyeglasses (with her art designs).
After 2 more than years, Jerry's optometry practice grows to $600,000/year in revenue, and his wife's divide eyeglass business (sold in Jerry's medical offices) generates $15,000 of acquirement. Normally, an eyeglasses business is not an SSTB, but because Elaine'south eyeglass business is nether mutual ownership with Jerry'south optometry business concern (via the shared attribution rules for married couples), and they share expenses (since she uses Jerry'south function space to sell her glasses), and the eyeglass revenue is only 2.4% of the combined $15,000 + $600,000 = $615,000 revenue, whatsoever profits on Elaine's eyeglass business organization will be treated as SSTB income (phasing out their QBI deduction altogether given Jerry's loftier income).
Further complicating the matter is the fact that a business conducting both SSTB-related and non-SSTB-related activities may periodically change from an SSTB to a non-SSTB (or vice versa), and back again, depending upon the ratio of SSTB-related acquirement to total revenue each twelvemonth.
This is possible considering, under the proposed regulations, the de minimis rule states that:
"For a trade or business organisation with gross receipts of $25 one thousand thousand dollars or less for the taxable year , a trade or business is not an SSTB if less than 10 percent of the gross receipts of the merchandise or business organization are attributable to [an SSTB]". (emphasis added)
The key point is that the proposed regulations' stipulate that the de minimis rule is applied separately "each taxable year." As a result, the determination of whether a business conducting both SSTB-related and non-SSTB-related activities is itself an SSTB is an annual test, based on whether the SSTB-related revenue is more than than ten% (or in the case of >$25M revenue businesses, more than five%) in each year!
The lxxx/l "Spin-off Killer" Rule (A.K.A. The Anti- "Crack and Pack")
Most immediately later the Tax Cuts and Jobs Act's cosmos of IRC Section 199A, practitioners went to work dissecting the new department and coming up with artistic means to allow clients to claim greater deductions.
Ane of the well-nigh widely discussed strategies for high-income business owners was something that came to be known as the "crack and pack." In brusk, the "crack and pack" was simply the idea of spinning off certain elements of an SSTB – often business-owned real manor - into a separate, commonly-owned entity, in guild to shift income from an SSTB (for which a QBI deduction on profits may have been phased out) to a not-SSTB (for which a QBI deduction on profits may nevertheless be available).
Unfortunately, the proposed regulations put a astringent wrinkle – if not a death knell – in the "crack and pack," thanks to the new "eighty/fifty rule" outlined in Section 199A-5(c)(2) of the regulations.
Nether this provision, if a "not-SSTB" has 50% or more common ownership with an SSTB, and the "non-SSTB" provides 80% or more of its holding or services to the SSTB, the "non-SSTB" will, past regulation, be treated every bit office of the SSTB.
Example #four: Betty is a doctor, and is the sole owner of her practice, which is organized as an LLC. The net income from her practice – which falls under the "wellness" services category of the SSTB definition – is $800,000 per year. As a result, Betty cannot merits a QBI deduction. Betty's LLC also owns the medical office out of which she practices, having purchased it several years ago for $2,000,000.
Prior to the issuance of the proposed regulations, one strategy Betty might have contemplated with her tax planner was spinning the medical office out into a dissever LLC, or other business structure, and having the medical practice pay hire to the rental business organisation for its use of the property. Prevailing wisdom was that while the profits of the medical practice would have been ineligible for the QBI deduction, the profits from at least the new (now-separate) rental business would have eligible for at least a partial QBI deduction (finer converting that portion of the income from SSTB to non-SSTB income).
The proposed regulations make clear that such a series of transactions would now be fruitless. Assuming that Betty's medical practice connected to utilise 100% of the office space later it was spun out into a new entity, she would be in "violation" of the "80" part of the 80/l dominion, since more than eighty% of the non-SSTB's holding would be used by a SSTB. Similarly, assuming she was the owner of the concern into which the medical office was transferred, she would exist in violation of the "50" office of the fourscore/50 rule, since the mutual buying between the SSTB and the non-SSTB would be 100%! Thus, the rental business and its income would, by rule, nonetheless be treated as an SSTB.
The "all-time" way to "beat" the 80/50 rule will frequently exist to "assault" the "50" part of the rule past trying to get the common ownership between the SSTB and the non-SSTB business entities below 50%. Once the common ownership (which includes both direct and indirect buying by related parties) betwixt the two entities is less than 50%, the anti-"fissure and pack" rules don't use, and the non-SSTB will actually be treated every bit a non-SSTB!
Notably, trying to avoid the 80/50 rule by just ensuring the SSTB business uses less than eighty% of the non-SSTB's property and services (eastward.thousand., by buying the entire medical office complex, renting out the other suites, and using just a small portion of the office space for the commonly endemic medical practice) will only be of limited effectiveness. The reason is that, under the rules, if a "non-SSTB" is providing less than lxxx% of its services/property to a 50%-or-greater commonly-owned SSTB, a portion of the business's profits volition still be considered part of an SSTB! In such situations, the portion of the business'southward services/property that is not provided to the commonly-owned SSTB will not be treated equally an SSTB, simply the portion of business's services/property that is provided by ordinarily-owned SSTB will still be treated equally an SSTB!
Example #5: Kanwe Beatum, LLC, is a law firm, and thus, an SSTB. The owners of the business firm have recently decided to purchase a large office building in a divide (but commonly endemic) entity, Fancy Offices, LLC, of which 40% volition be rented to Kanwe Beatum at fair market place value to deport future operations, while the other 60% will be rented to unrelated businesses.
Here, only 40% of the non-SSTB Fancy Offices property (the edifice) volition be provided to the SSTB law business firm (which is lower than the 80% threshold). The buying, however, between Kanwe Beatum, LLC and the Fancy Offices entity in which the office building is purchased is identical (≥fifty%). Equally a consequence, 40% of Fancy Offices will exist treated as an SSTB (i.e., xl% of its acquirement and profits will be bailiwick to the SSTB phaseout tests), while the remaining 60% will not.
Ultimately, the "good" news of the new SSTB rules is that they withal only apply to a limited subset of small business organisation owners – those that do engage in at least some level of "specified services", and take income that is high enough to exceed the thresholds ($157,500 for individuals and $315,000 for married couples) where the QBI phaseout kicks in. Nonetheless, for loftier-income small business owners who do run into those thresholds and accept specified service income, careful planning volition be more of import than ever to avoid running afoul of the new rules, especially with respect to trying to carve up (and avert "tainting") non-SSTB income from the less-taxation-favored income of specified service businesses.
Is My Business A Specified Service Trade Or Business,
Source: https://www.kitces.com/blog/sstb-specified-service-business-de-minimis-rule-crack-and-pack-80-50-rule-qbi-deduction/
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