In a prior blog post, we addressed rules in the proposed regulations for the treatment of a trade or business that is not a specified service trades or business (“SSTB”) but has some relatively small elements that are attributable to the performance of services in a field that would qualify as an SSTB. The topic of this post is the rules for the treatment of an SSTB that has some incidental or relatively small non-SSTB elements, which are contained in Section 1.199A-5(c)(3).
Under these rules, if a non-SSTB has (1) 50% or more common ownership with an SSTB, (2) shares expenses, such as shared wages or overhead expenses, with the SSTB, and (3) gross receipts that are no more than 5% of the total combined (SSTB and non-SSTB) gross receipts, then the non-SSTB will be treated as part of the SSTB for Section 199A purposes. Common ownership is determined by applying the related party rules in Sections 267(b) and 707(b).
The proposed regulations provide an example where a dermatologist provides medical services to patients and also sells skin care products to patients. The same employees and office space are used for the medical services and the sale of skin care products. The gross receipts of the skin care product sales do not exceed 5% of the combined gross receipts. Under the rule, the sale of the skin care products (which is not an SSTB) will be treated as incident to, and part of, the medical service SSTB. Therefore, the qualified business income, w-2 wages, and any unadjusted basis of qualified property attributable to the skin care products business will not be eligible for Section 199A purposes unless the dermatologist is under the taxable income thresholds specified in Section 199A.
The proposed regulations do not address a scenario where the gross receipts of the skin care products business were, for example, 6% of the total combined gross receipts. Presumably, the skin care products business would then be considered a separate trade or business (a non-SSTB) from the dermatology practice, which would be an SSTB. A potential gotcha is for a business that is an SSTB that is entrepreneurial and tries to expand into a business that is not a SSTB. For example, consider a financial services business that starts-up a business to create personal budgeting and retirement software and that uses some of the employees and office space of the financial services business. Unless and until either (1) the gross receipts of the software start-up exceeds 5% of the combined gross receipts or (2) there are no longer any shared expenses, then the software business will be treated as a part of the financial services SSTB.