Proposed Regulations to Section 199A Pass-Through Business Deductions

By Elizabeth Herbst

On August 8th, the IRS issued proposed regulations addressing the new Section 199A 20-percent deduction for pass-through business. Section 199A of the Internal Revenue Code provides owners of pass-through businesses, generally partnerships and S corporations, a deduction for qualified business income from a qualified trade or business. The new proposed regulations clarify some previously ambiguous sections of Section 199A related to what types of business activities are eligible for the deduction.

Section 199A

As written, Section 199A provides eligible taxpayers a deduction up to 20 percent of qualified business income from a domestic business that is structured as a sole proprietor, partnership, S corporation, trust, or estate. For taxpayers with taxable income that exceeds $315,000 for a married couple filing jointly or $157,500 for all other taxpayers, the deduction is subject to limitations such as the type of business, the taxpayer’s taxable income, the total amount of W-2 wages paid by the business or the unadjusted basis of qualified property held by the business.

Proposed Regulations to Section 199A

The recently issued proposed regulations address questions taxpayers and tax practitioners have regarding the application of the new law:

One of the most questioned parts of Section 199A is what types of business or activities are excluded from the 20 percent deduction.

Section 199A defined specified service business, for which no deduction is allowed once a taxpayer’s taxable income exceed $415,000 for taxpayers filing jointly or $207,500 for all other taxpayers, 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”.

De Minimus Exception

The proposed regulations clarified several questions related to specified service businesses. First, there is a de minimis exception that allows a business that sells products and provides a service to escape classification as a specified service business if the business’ gross receipts are less than $25 million for the year and less than 10% of total gross receipts are from the performance of services in one of the specified services business listed above.

Next, the proposed regulations provide guidance on the meaning of various trades of business described in Section 199A as specified service business. A few of the most common questions we have received involve services performed in health, consulting, and real estate.

Specific Services

Health– The term “performance of services in the field of health” as it relates to a specified service business 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.  It does not include the provision of service not directly related to a medical field, even though services may purportedly relate to the health of the service recipient.  An example of this would be the operation of a health club or health spa that provides exercise or conditioning to customers, payment processing services for health care providers, and the research, testing, and manufacture and or sale of pharmaceuticals.

Consulting- Section 199A includes consulting as provision of professional advice and counsel to clients to assist in achieving goals and solving problems as a specific service business.  The proposed regulations indicate that consulting does not include salespeople who provide training or education courses as an ancillary service to the sale of product.  As an example, a construction contractor who provides consultation as part of a kitchen remodel is not considered a consultant.

Real Estate- Brokerage services are specifically listed as a specified service business in Section 199A. This includes services provided by stock brokers and other similar professionals but does not include services provided by real estate agents and brokers or insurance agents or brokers.  Additionally, current Section 199A includes “investing and investment management” as a specified service business excluded from the Section 199A deduction. The proposed regulations clarify the performance of investing and managing real property are not included in this definition, allowing for real estate professionals in the trade or business or managing real property to qualify for the deduction.

If you have questions regarding the proposed Section 199A regulation changes and how they will affect your business, it’s a good time to contact a DHJJ CPA.

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