The 20% Pass-Through Deduction – What is a Specified Service Trade or Business?
October 15, 2018
By Richard J. Shapiro
As previously noted in a recent EisnerAmper alert, the Tax Cuts and Jobs Act introduced a new 20% pass-through deduction (subject to statutory requirements and limitations) – IRC Sec. 199A – for business taxpayers other than corporations. In August 2018, the Treasury issued proposed IRC Sec. 199A regulations (the “Proposed Regulations”) to provide needed clarity to this significant new Code section. According to the preamble to the Proposed Regulations, taxpayers may rely on the Proposed Regulations until final regulations are published.
In general terms, IRC Sec. 199A provides that only items attributable to a “qualified trade or business” are taken into account in determining the IRC Sec. 199A deduction. The statute provides that a qualified trade or business means any trade or business other than a specified service trade or business (“SSTB”) (or the trade or business of performing services as an employee).
Two exceptions should be noted. First, individuals with taxable income below a threshold amount – $157,500, $315,000 for married taxpayers filing jointly – are not subject to the SSTB restriction; if an individual or trust has taxable income below the threshold amount, the individual or trust is eligible to receive the IRC Sec. 199A deduction notwithstanding that a trade or business is an SSTB. Individuals with an SSTB and taxable income between $157,500 and $207,500 (taxable income between $315,000 and $415,000 in the case of married taxpayers filing jointly) may qualify for a portion of the IRC Sec. 199A deduction. Second, there is a de minimis rule, under which a trade or business is not considered to be an SSTB merely because it provides a small amount of services in a specified service activity. Specifically, a trade or business 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 a specified service activity. For a trade or business with gross receipts greater than $25 million in a taxable year, the safe harbor is less than 5% of gross receipts.
An SSTB is (1) 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, and (2) any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests or commodities.
Under the Proposed Regulations, whether or not a service is deemed to be performed in one of the enumerated fields for IRC Sec. 199A purposes is not to be controlled by state licensing laws – the Proposed Regulations do not adopt a bright-line licensing rule.
The Proposed Regulations provide added insight into what is covered by the SSTB enumerated fields.
The performance of services in the field of “health” is the provision of medical services by health care professionals who provide medical services directly to a patient. It does not include services not directly related to a medical field, even though they may purportedly related to the health of the service recipient. So, for example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to customers, payment processing, or research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.
This includes the provision of services by lawyers, paralegals, legal arbitrators and mediators. It does not include the provision of services by printers, delivery services or stenography services.
“Accounting” is the provision of services by accountants, enrolled agents, return preparers and financial auditors; licensing as a certified public accountant (CPA) is not required. Payment processing and billing analysis is not included in the field of accounting.
The performance of services in the field of “actuarial science” is the provision of services by actuaries and similar professionals in their capacity as such, but it does not include services by analysts, economists, mathematicians, and statisticians not engaged in analyzing or assessing the financial costs of risk or uncertainty of events.
This category includes the performance of services by individuals who participate in the “creation” of performing arts, such as actors, singers, musicians, entertainers and directors. It does not include the provision of services that do not require skills unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities for use in the performing arts. It does not include services by persons who broadcast or disseminate video or audio of performing arts to the public.
Consulting is the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems. It 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. It does not include the performance of services other than advice and counsel, such as sales or economically similar services or the provision of training and educational courses. What if consulting services are provided in connection with the purchase of goods by customers? As previously noted and particularly relevant to this SSTB, the Proposed Regulations provide a de minimis rule – a trade or business is not an SSTB if less than 10% of the gross receipts (less than 5% if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. As further relief, the field of consulting does not include consulting that is embedded in, or ancillary to, the sale of goods or performance of services that is otherwise not an SSTB (such as typical services provided by a building contractor) if there is no separate payment for the consulting services.
The performance of services in the field of “athletics” is the performance of services by individuals who participate in athletic competition. It does not included the provision of services that do not require skills unique to athletic competition, such as the maintenance and operation of equipment or facilities for uses in athletic events. Also, it does not include the provision of services by persons who broadcast or otherwise disseminate video or audio of athletic events to the public.
The definition of financial services is limited to services typically performed by financial advisors, investment bankers, wealth planners and retirement advisors, as well as the provision of financial services to clients, including 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 and raising financial capital by underwriting or acting as the agent in the issuance of securities. It does not include taking deposits or making loans.
The field of brokerage services includes services in which a person arranges transactions between a buyer and seller with respect to securities for a commission or fee. It includes services provided by stock brokers and similar professionals but not services provided by real estate agents and brokers, or insurance agents and brokers.
Investing and Investment Management
This category involves a trade or business that earns fees -- a commission, flat fee or an investment management fee calculated as a percentage of assets under management -- for investment, asset management services, or investment management services including providing advice with respect to buying and selling investments. This does not include directly managing real property.
The term “trading” for purposes of IRC Sec. 199A appears to be used in the traditional asset management “trader” versus “investor” versus “dealer” context. The performance of services that consist of trading means a trade or business of trading in “securities,”1 “commodities” or partnership interests. Factors that have been considered relevant in determining whether a person is a trader include the source and type of profit that is associated with engaging in the activity regardless of whether that person trades for his own account, for the account of others, or a combination of both. A taxpayer, such as a manufacturer or a farmer, who engages in hedging as part of their trade or business of manufacturing or farming is not considered to be engaged in the trade or business of trading commodities.
Dealing in Securities, Partnership Interests and Commodities
Dealing in securities involves regularly purchasing securities from and selling securities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. A taxpayer that regularly originates loans in the ordinary course of a trade or business of making loans but engages in no more than “negligible” sales of the loans is not dealing in securities for purposes of IRC Sec. 199A. “Securities” and “commodities” for this purpose utilize their mark-to-market accounting method for dealers definitions in IRC Sec. 475.
The performance of services that consist of dealing in partnership interests means regularly purchasing partnership interests from and selling partnership interests to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in partnership interests with customers in the ordinary course of a trade or business.
Any Trade or Business Where the Principal Asset is the Reputation or Skill of One or More of Its Employees or Owners
According to the preamble to the Proposed Regulations, the Treasury Department and the IRS believe that the “reputation or skill” language was intended to describe a narrow set of trades or businesses not otherwise covered by the enumerated SSTBs, in which income is received based directly on the skill and/or reputation of employees or owners. Accordingly, the Proposed Regulations limit the meaning of “reputation or skill” to fact patterns in which the individual or the relevant pass-through entity is engaged in any of the following three trades or businesses: (1) receiving income for endorsing products or services; (2) 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; or (3) receiving appearance fees or income (or reality performers performing as themselves; radio, television, and other media hosts; and video game players). This limitation is significant. A broad interpretation of this language could have eliminated a substantial portion of taxpayers from eligibility for the IRC Sec. 199A deduction.
No doubt, the definition of many of the above SSTBs will be refined in final regulations to reflect the various comments, concerns and questions that are being raised.
1 Throughout the SSTB provisions, the Proposed Regulations cross reference to the definition of “securities” and “commodities” in IRC Sec. 475. That Code section addresses the mark-to-market accounting method for dealing in securities, and also addresses dealers in commodities as well as mark-to-market for traders in securities or commodities.