Presumably, 90 percent of those in Congress are attorneys, and good ones. So, you'd think their contracts and legislation wouldn’t leave a lot of things up to interpretation. Unfortunately, this isn't really the case.
We all know the TCJA was rushed through Congress and signed by the President, leaving practitioners and the IRS with a whole host of questions, particularly surrounding the IRC §199A deduction.
In theory, 199A is supposed to provide owners of pass-thru companies a 20% deduction on qualified business income (QBI). However, Notice 2019-7, 2019-9 IRB 740, coupled with Rev. Proc. 2019-11, 2019-9 IRB 742 and, finally, Reg. 1.199A-5(a)(2), has created a mess for practitioners. This article is going to focus mainly on Reg. 1.199A-5(a)(2).
The main impact of the final regulations is upon the definition of a Specified Service Trade or Business (SSTB). Reg. 1.199A-5(a)(2) provides that if a trade or business is an SSTB, no qualified business income (QBI), W-2 wages or unadjusted basis immediately after acquisition (UBIA) of qualified property from the SSTB may be taken into account by any individual whose taxable income exceeds the phase-in range as defined at Reg. 1.199A-1(b)(4), even if the item is derived from an activity that is not itself a specified service activity.
The final regulations continue the expansive definitions of an SSTB set fort in the proposed regulations, despite the IRS having received many comments recommending changes. Many of these comments argued that the classification of a service business as an SSTB should be limited to the definitions provided in Reg. 1.448-1(T)(e)(4), regarding a qualified personal service corporation not prohibited from using the cash method of accounting by Section 448. Unfortunately, the IRS concluded that “it is both necessary and consistent with the statute and the legislative history to expand the definitions of the fields of services listed in Section 199A(d)(1) and (2) and Reg. 1.199A-5 beyond those provided in Reg. 1.448-1T(e)(4).” So, what exactly is an SSTB? These regulations and guidance read like, “If it’s Tuesday, raining and your car stalled…”
Health is one of the professions listed as an SSTB in Reg. 1.199A-5(b)(1)(i). Several aspects of providing healthcare services are addressed in the final regulations.
SKILLED NURSING AND ASSISTED LIVING FACILITIES
Some commentators noted that many services provided by skilled nursing and assisted living facilities, such as housing, meals, laundry, security and socialization activities, are not related to healthcare. The IRS determined that whether the owners of such a facility are performing services in the field of health requires an inquiry into the facts and circumstances that is beyond the scope of the final regulations. However, the final regulations contain the following example of such facilities that do not rise to the level of performance of services in the field of health.
A is the operator of a residential facility that provides a variety of services to senior citizens who reside in the premises. For residents, A offers standard domestic services, including housing management and maintenance, meals, laundry, and entertainment. In addition, A contracts with local professional healthcare organizations to offer residents a range of medical and health services provided at the facility, including skilled nursing care, physical and occupational therapy, speech-language pathology services, medical social services, medications, medical supplies and equipment used in the facility, ambulance transportation to the nearest supplier of needed services and dietary counseling. A receives all of its income from residents for the costs associated with residing at the facility. Any health and medical services are billed directly by the healthcare providers to the senior citizens for those professional healthcare services, even though those services are provided at the facility. The IRS concludes that A does not perform services in the field of health within the meaning of Section 199A(d)(2).
But wait, there’s more.
OTHER HEALTHCARE FACILITIES
Some health care facilities, such as emergency centers, urgent care centers and surgical centers, provide improved real estate and equipment but do not directly provide treatment or diagnostic care to those seeking treatment, even though one of the owners of the facility do provide medical services on the premises.
Again, from the final regs:
B operates specialty surgical centers that provide outpatient medical procedures that do not require the patient to remain overnight for recovery or observation following the procedure. B is a private organization that owns a number of facilities throughout the country. For each facility, B ensures compliance with state and federal laws for medical facilities and manages the facility's operations and performs all administrative functions. B does not employ physicians, nurses or medical assistants, but instead enters into agreements with other professional medical organizations or directly with the medical professionals to perform the procedures and provide all medical care. Patients are billed by B for the facility costs relating to their procedure and separately by the healthcare professional or their affiliated organization for the actual costs of the procedure conducted by the physician and medical support team. The IRS concludes that B does not perform services in the field of health within the meaning of Section 199A(d)(2).
Because other healthcare facilities don’t hire any healthcare professionals, right?
The IRS cited Rev. Rul. 91-30, 1991-1 CB 61, which held that a corporation whose employees perform veterinarian services is a qualified personal service corporation within the meaning of Sections 448(d)(2) and 11(b)(2) and a qualified personal service corporation within the meaning of Section 441(i). Therefore, the IRS concluded that it was appropriate to continue the long-standing treatment of veterinarian services as services in the field of health for the purposes of Section 199A.
It just gets better…
In the examples of skilled nursing facilities and those facilities, such as outpatient surgical centers, that offer separate services, the IRS agreed that providing health services at a facility did not taint the non-health services such as housing, meals and laundry, as long as the medical services were separately billed. Therefore, it would seem that those veterinary practices that have other streams of income, such as boarding and grooming services, should separately bill for health services to prevent the non-health ones from being classified as an SSTB.
Unfortunately, the final regulations do not make clear whether separate billing is a newly established test or is merely a new factor in determining whether two trades or businesses are separate.
SEPARATE TRADES OR BUSINESSES
If two or more trades or business are operating within one RPE, and one is an SSTB and the other is a qualified trade or business (QTB) that is fully eligible for the Section 199A deduction if they have sufficient W-2 wages and UBIA of qualified property, to maximize the benefits of Section 199A to the QTB, they should operate as two separate trades or businesses under Section 446(d). The IRS believes that multiple trades or businesses will generally not exist within an entity unless different methods of accounting could be used for each trade or business under Reg. 1.446-1(d).
Reg. 1.446-1(d) explains that no trade or business is considered separate and distinct unless a complete and separable set of books and records is kept for that trade or business. Further, trades or businesses will not be considered separate and distinct if, by reason of maintaining different methods of accounting, there is a creation or shifting of profits and losses between the businesses of the taxpayer so that income of the taxpayer is not clearly reflected. As discussed above, the final regulations do not make clear whether separate billing is now a part of the separate trade or business test.
One practitioner has noted that “[s]uccessfully arguing that a taxpayer has separate businesses requires a factual determination, and factors include whether the employees are separate, whether the operations are distinct, and whether the businesses are in different locations.” Another practitioner stated that “ideally, we like to see distinct product or service lines that have different customers, separate bank accounts and lines of credit” and noted that it is also helpful to see that “the business doesn't have only internal customers.”
Let’s take this a little further. As noted above, Reg. 1.446-1(d) explains that no trade or business is considered separate and distinct unless a complete and separable set of books and records is kept for that trade or business. So, to get this 20 percent deduction, I should form another entity for the business that qualifies for the 199A deduction, spend money to incorporate it, spend money for accounting services and spend money to file a tax return. So, that 20 percent deduction magically disappears.
The IRS agreed that the sale of pharmaceuticals and medical devices by a retail pharmacy is not, by itself, a trade or business performing services in the field of health. However, Reg. 1.199A-5(b)(3), Example 1, provides that a board-certified pharmacist who serves as an independent contractor to a medical facility and is responsible for receiving and reviewing orders from physicians at the facility, making recommendations on dosing and alternatives to the ordering physician, performing inoculations, checking for drug interactions and filling pharmaceutical orders for patients is engaged in the performance of services in the field of health within the meaning of Section 199A(d)(2).
FURNISHED DIRECTLY TO THE PUBLIC
Prop. Reg. 1.199A-5(b)(2)(ii) provided that performance of services in the field of health means the provision of medical services by individuals such as physicians and other healthcare professionals directly to a patient. The final regulations eliminate the requirement that the services be provided directly to a patient. As a result, a radiologist who acts as an expert consultant to a physician but does not provide services directly to a patient will be considered as performing health services and thereby will be classified as an SSTB.
However, the final regulations did agree with another commentator's observation that those who are not required to exercise medical judgment might not be performing services in the field of health, but noted that this is a question of fact.
From the final regs:
C is the developer and only provider of a patented test used to detect a particular medical condition. C accepts test orders only from healthcare professionals (C's clients) but does not have contact with patients, and C's employees do not diagnose, treat or manage any aspect of patient care. A, who manages C's testing operations, is the only employee with an advanced medical degree. All other employees are technical support staff, not healthcare professionals.
Upon completion of an ordered test, C analyzes the results and provides its professional clients with a report summarizing the findings. C does not discuss the report's results or the patient's diagnosis or treatment with any healthcare provider or the patient. C is not informed by the healthcare provider as to the healthcare provider's diagnosis or treatment. C is not providing services in the field of health within the meaning of Section 199A(d)(2).
Got a headache yet? I'll take a break here so you can recover. Look for part two of this column soon.