Section 199A Confusion: Specified Service Trade or Business
We’ve written before about the Section 199A deduction of the Tax Cuts and Jobs Act (TCJA). The new law allows individuals and trusts to take a deduction of up to 20% of qualified business income, or QBI, from a domestic qualified trade or business.
However, there is a limitation placed on the deduction if your taxable income is over a certain threshold - $157,500 for a single filer, $315,000 for married filers – relating to qualified business income that is earned from a “specified service trade or business” (SSTB).
If you're confused already, here's what you need to know to understand how Section 199A impacts your taxable income.
How Does the IRS Define a "Specified Service Trade or Business?"
The IRS defines a Specified Service Trade or Business as “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 one or more of its employees or owners.” (While the last item can be somewhat confusing, the IRS has clarified that it refers more to the idea of individuals who make product endorsements or testimonials for compensation).
The IRS operates very broadly in categorizing businesses that involve the above activities as SSTBs, and high-income taxpayers can lose out on the Section 199A deduction completely if their income is derived from one of these businesses.
A Broad Definition, Lots of Confusion
Worse yet, the IRS, by making the definition so broad, has provided very little recourse for partners and shareholders in businesses that perform services in these fields. For small businesses, even if only 10% of receipts are derived from an SSTB, the entire enterprise is considered an SSTB. For larger businesses it is even more restrictive; the cutoff point is 5% of receipts.
For example, an ophthalmologist who derives a portion of his or her income selling glasses to patients can have the entire business designated an SSTB and miss out on the Section 199A deduction – while selling glasses is not a specified service trade or business, ophthalmology is a performance of services in the field of health and is classified as an SSTB.
Maximize Your Section 199A Deduction
If you are a high-income taxpayer earning business income from an enterprise classified as an SSTB, you may be understandably worried at this point. All is not lost, however. The IRS, in its most recently issued final regulations, offers a way around this provision in certain circumstances. Proper tax planning is the key to maximizing the Section 199A deduction. We’re ready to help you with all your planning needs, including an analysis of your books and records and proper business structuring and entity choice. Contact us to get started.