More on the Section 199A Deduction Mess
In part two of my take on the Section 199A deduction mess, I'd like to address a couple other areas the regulations discuss.
The IRS determined that the provision of services in the field of accounting is not limited to services requiring state licensure but, instead, is based on a common understanding of accounting, which includes tax return and bookkeeping services. Whether a real estate settlement agent is engaged in the performance of services in the field of accounting depends on the facts and circumstances, including the specific services offered and performed by the trade or business.
So basically: Who knows?
Reg. 1.448-1T(e)(4)(ii) defines services in the field of preforming arts as “the provision of services by actors, actresses, singers, musicians, entertainers, and similar artists in their capacity as such.” The proposed regulations created a lot of controversy by expanding the definition in Prop. Reg. 1.199A-5(b)(2)(vi) to include those who “participate in the creation of performing arts” and thereby explicitly added “directors and similar professionals.” The term “similar professionals” likely includes producers, set designers, costume designers, and stagehands. The final regulations also make clear that writers might be included to the extent they are “paid for written material, such as a song or screenplay, that is integral to the creation of the performing arts.”
And the regs give two examples on this one:
D, a singer and songwriter, writes and records a song. D is paid a mechanical royalty when the song is licensed or streamed. D is also paid a performance royalty when the recorded song is played publicly. D is engaged in the performance of services in an SSTB in the field of performing arts within the meaning of Section 199A(d)(2) or Reg. 1.199A-5(b)(1)(v) and (b)(2)(vi). The royalties that D receives for the song are not eligible for a deduction under Section 199A.
E is a partner in Movie LLC, a partnership. Movie LLC is a film production company. Movie LLC plans and coordinates film production. Movie LLC shares in the profits of the films that it produces. Therefore, Movie LLC is engaged in the performance of services in an SSTB in the field of performing arts within the meaning of Section 199A(d)(2). E is a passive owner in Movie LLC and does not provide any services with respect to Movie LLC. However, because Movie LLC is engaged in an SSTB in the field of performing arts, E's distributive share of the income, gain, deduction, and loss with respect to Movie LLC is not eligible for a deduction under Section 199A.
DE MINIMUS EXEMPTION
The proposed regulations provide that a trade or business with gross receipts of $25 million or less for the taxable year is not an SSTB if less than 10 percent of the gross receipts of the trade or business are attributable to the SSTB. The percentage is reduced to 5 percent in the case of trades or businesses with gross receipts in excess of $25 million. After considering all of the comments, the IRS chose to retain the 5 percent threshold in the final regulations as it is a de minimis threshold that is generally consistent with prior regulations under the Code in similar circumstances, and, therefore, such a standard should be familiar to affected entities.
The final regulations retain the proposed rule but add an additional example demonstrating the result in which a trade or business has income from a specified service activity in excess of the de minimis threshold. Trades or businesses with gross income from a specified service activity in excess of the de minimis threshold are considered to be SSTBs.
The IRS acknowledged that an RPE can have more than one trade or business for purposes of Section 162 and thus for Section 199A. However, each trade or business is required under Section 199A to be separately tested to determine whether that trade or business is an SSTB. Similarly, the de minimis threshold is applied to each trade or business of an RPE separately, not in the aggregate to all the trades or businesses of the RPE. Thus, to the extent that an individual or RPE has more than one trade or business, the presence of specified service activity in one of those trades or businesses will not cause the individual's or RPE's other trades or businesses to be considered SSTBs except to the extent that the rules in Reg. 1.199A-5(c)(2) (services or property provided to an SSTB, as discussed below) apply.
And another example from the regs:
G, which is organized as an LLC, provides veterinarian services performed by licensed staff and also develops and sells its own line of organic dog food at its veterinarian clinic and online. The veterinarian services are considered to be the performance of services in the field of health under Reg. 1.199A-5(b)(1)(i) and (b)(2)(ii). G separately invoices for its veterinarian services and the sale of its organic dog food. G maintains separate books and records for its veterinarian clinic and its development and sale of its dog food. G also has separate employees who are unaffiliated with the veterinary clinic and who only work on the formulation, marketing, sales, and distribution of the organic dog food products. G treats its veterinary practice and the dog food development and sales as separate trades or businesses for purposes of Section 162 and Section 199A. G has gross receipts of $3 million. $1 million of the gross receipts is attributable to the veterinary services, an SSTB. Although the gross receipts from the services in the field of health exceed 10% of G's total gross receipts, the dog food development and sales business is not considered an SSTB due to the fact that the veterinary practice and the dog food development and sales are separate trades or businesses under Section 162.29.
SEPARATE BUSINESSES EARLY
Some practitioners have suggested that taxpayers might be wise to separate businesses early to avoid the risk of growing out of the de minimis exception. One example is a bank, organized as an S corporation, that initially earned a relatively small amount of income from an SSTB but did not treat it as a separate trade or business from the beginning. The bank might find it harder to argue that the businesses are separate if the SSTB grows beyond the limits of the de minimis rule.
For example, a bank with over $25 million in gross receipts earns 3 percent of those receipts from wealth management, otherwise an SSTB, for three consecutive years where the bank reported as only one trade or business in computing its QBI. If in the fourth year, the bank acquired another wealth management business, and its gross receipts from wealth management therefore grew to 8 percent (over the de minimis threshold), the bank might find it very difficult to claim that wealth management is a separate trade or business.
Common ownership where services or property are provided to an SSTB:
The proposed regulations provided special rules for service or property provided to an SSTB by a trade or business with common ownership. Under these rules, a trade or business that provides more than 80 percent of its property or services to an SSTB (as opposed to third party customers or clients) is treated as an SSTB if there is 50 percent or more common ownership of the trades or businesses. In cases in which a trade or business provides less than 80 percent of its property or services to a commonly owned SSTB, the portion of the trade or business providing property to the commonly owned SSTB is treated as part of the SSTB with respect to the related parties.
The final regulations make two important changes to the proposed regulations. First, the final regulations clarify that the rule applies only to those who make up the 50 percent test and now provide that Sections 267(b) and 707(b) apply in determining common ownership for purposes of the aggregation rules. This change allows grandparents, siblings and adopted children to be included. Second, the final regulations provide that if a trade or business provides property or services to an SSTB and there is 50 percent common ownership of the trade or business, the portion of the trade or business providing property or services to the 50 percent commonly owned SSTB will be treated as separate with respect to related parties.
Incidental to an SSTB:
In the final regulations, the IRS removed the proposed regulations providing that if a trade or business (that would not otherwise be treated as an SSTB) has both 50 percent or more common ownership with an SSTB and shared expenses with an SSTB, the trade or business is treated as incidental to and, therefore, part of the SSTB. This is only if the gross receipts of the trade or business represent no more than 5 percent of the total combined gross receipts of the trade or business and the SSTB in a taxable year.
Basically, to get around this nonsense, you need to separate the 199A business from the non-199A company, creating more fees and headaches for the clients.
Convert these companies to C corporations, and even if double taxation comes into play, your clients will thank you.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...