While much of the Tax Cuts and Jobs Act of 2017 was focused on individual and corporate tax reform and simplification, one of the biggest new planning opportunities that emerged was the creation of a new 20% tax deduction for “Qualified Business Income” (QBI) of a pass-through entity, intended to provide a tax boon to small businesses that would leave more profits with the business to help it grow and hire.
The caveat, however, is that the QBI deduction was only intended to provide tax benefits for profitable businesses that hire employees, not to provide tax benefits for high-income professions who generate their profits directly from their own personal labors. As a result, the new IRC Section 199A created a so-called “Specified Service Business” classification that, at higher income levels, would not be eligible for the QBI deduction.
The challenge, however, is that the exact definition of what constitutes a “Specified Service Trade or Business” (SSTB) has not always clear, given the wide range of professional services that exist in the marketplace. In addition, as soon as the rules themselves were released, creative tax planners began to strategize about how to arrange (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 post, Jeffrey Levine of BluePrint Wealth Alliance, and our Director 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 will apply in various industries, including rather broadly for professions like health, law, and accounting, but only narrowly to high-profile celebrities who may have their endorsements and paid appearances treated as specified service income but not the income from their other businesses that may still materially benefit from their high-profile reputation.
Of greater significance for many small business owners, though, are new rules that will force businesses with even just modest specified service income to treat the entire entity as an SSTB, limit the ability of specified service businesses to “carve off” their non-SSTB income into a separate entity, and in many cases aggregate together multiple commonly owned SSTB and non-SSTB business for tax purposes.
Ultimately, the new rules are only impactful for the subset of small business owners who engage in specified service business 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 owners, effective planning to avoid having SSTBs “taint” non-SSTB income, or to split off non-SSTB income to the extent possible, will be more challenging than before.