IRC 199A: What is a Specified Service Trade or Business? – Part IV

Take-Away: The IRC 199A 20% income tax deduction is not available for high wage earners based on whether their business entity engages in certain service activities, referred to as Specified Service Trade or Businesses as identified in the proposed IRC 199A Regulations. The eligibility for the income tax deduction is also based on the amount of wages paid or the qualified property placed in service by that business entity for the year. Once a taxpayer has significant taxable income ($157,000 for a single filer, or $315,000 for a married filer) they must pass a wages or a wages/qualified property ‘test’ to avoid a significant decrease, or elimination of, their eligibility to claim the IRC 199A income tax deduction. The definitions of a Specified Service Trade or Business provided by the proposed Regulations are extraordinarily broad, and at times seemingly arbitrary.

Background: As noted previously, certain professions are, practically speaking, excluded from claiming an IRC 199A deduction (what I collectively called excluded professions.) While these professionals can still claim the IRC 199A income tax deduction if their income is below the reported threshold levels (and the deduction will be phased out if their reported incomes are above the threshold amounts) those excluded professions will be forced under the proposed Regulations to aggregate income from ancillary service businesses with their professional income, thus making it even less likely that a successful professional will ever qualify for the IRC 199A income tax deduction.

Scope of Excluded Professions: Some of the definitions of Specified Service Trade or Business, aka excluded professions, provided in the proposed IRC 199A Regulations follow:

Health: Includes: physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, ‘and similar healthcare professionals who provide medical services directly to the patient. Excluded: the operation of health clubs or spas, physical exercise or conditioning services to customers, the processing, payment or research, testing and manufacturing and/or sales of pharmaceuticals or medical devices.
Law: Includes: lawyers, paralegals, arbitrators, mediators, and similar professionals. Excluded: stenography, and document delivery services. Unclear: trustee and executor services, title insurance, or any other services that do not necessarily require a law license.
Accounting: Includes: Accountants, enrolled agents, tax return preparers, bookkeeping services, and similar reporting services NOT requiring a state license. Excluded: payment processing and billing analysis.
Actuary: Included: the profession is based on the ordinary meaning of ‘actuarial sciences’ –whatever that is! Excluded: economists, mathematicians, and statisticians not engaged in assessing the financial costs or risks or uncertainty of events.
Engineers and Architects: All are excluded, with no apparent explanation why they are treated differently than any other licensed profession [other than they probably had a good lobbyist in Washington that week.]

Consultants: Includes: lobbyists and those who provide advice and counsel with regard to advocacy; Excluded: those who perform services other than advice and counsel, which will use a ‘facts and circumstances’ test. Also excluded will be consulting services that are embedded in, or ancillary to, the sale of goods or the performance of services on behalf of a trade or business that is not otherwise an excluded profession, g. services provided by a building contractor if there is no separate payment for the contractor’s consulting services.
Performing Arts: Includes: individuals who participate in the creation of performing arts like actors, singers, musicians, entertainers, directors, etc. Excluded: persons who broadcast or disseminate video or audios of performing arts to the public, or those who maintain and operate equipment or facilities used in the performing arts. [Tony Romo apparently gets a pass.]
Athletics: Includes: athletes, coaches and team managers for almost any type of athletic event, e.g. bowling and billiards. Excluded: those whose services do not require skill unique to athletic competition, e.g. broadcasters, camera persons. [Jon Gruden should have stayed in the broadcasting booth!]
Financial Services: Includes: financial advisors, investment bankers, wealth managers, retirement plan advisors, advisory services regarding valuations associated with mergers, acquisitions, and business dispositions. Excluded: those who take deposits or make loans.
Brokerage Services: Included: transaction brokers between buyers and sellers for a commission or a fee, and stockbrokers. Excluded: real estate agents and brokers, insurance agents and insurance brokers.
Investment Management Services: Included: those who earn a fee or commission for providing investment, asset management services, and advice associated with buying and selling investments. Excluded: Services provided to directly manage real property.
Trading Services: Included: services associated with trading securities, commodities or partnership interests, whether or not that person trades for their own account, for others, or a combination. Excluded: a person who engages in hedging transactions as a part of their business.
Dealing in Securities: Included: purchasing and selling securities to customers in the ordinary course of trade or business, including the assumption, offset, assignment, or termination of positions in securities with customers. Excluded: a person who regularly originates loans in the ordinary course of business of making loans, but who can only participate in negligible sale of the loans (i.e. to not be classified as dealing in securities.)
Dealing in Commodities: Included: regularly purchasing commodities from and selling commodities to customers in the ordinary course of business. Excluded: a person who engages in hedging transactions as part of their own business.
“Catch-all:” Includes: where the principal asset of the trade or business is the reputation or skill of one or more employees or the owner if (i) fees or other compensation are received for the endorsement of products or services; (ii) license or fees are received for the use of an individual’s image, name voice, or personal trademark; or (iii) compensation is received for appearing at an event. Example: Famous chef Mario Batali owns a restaurant. His restaurant will qualify for the IRC 199A income tax deduction. However, any income earned by Mr. Batali as a license fee paid to him to use his name in connection with the sale cookware [the same for Martha, Emeril, Rachel, or Wolfgang] would be considered to be income earned from an excluded profession, for which the IRC 199A income tax deduction is unavailable.

Conclusion: High earning individuals in specific professions or businesses are generally ineligible to take advantage of the IRC 199A income tax deduction. For those folks, they need to consider adopting a planning strategy to establish a separate active trade or business to hold and lease real estate or equipment to their operating business or practice, but without any common ownership between the businesses. Or, for some of the Specific Service or Trade Businesses, to create multiple separate tax paying non-grantor trusts that own part of their operating business to reduce their high income to a level where they might qualify for a portion (or all) of the IRC 199A income tax deduction. Needless to say, these eligibility rules are extremely ambiguous when a large income tax deduction hangs in the balance on how an individual’s business is ultimately classified. Hopefully the final Regulations will provide clearer guidance than these vague categories.