Tag Archives: 199A

Final Section 199A Regulations Provide Little Guidance for Skilled Nursing and Assisted Living Facilities

The final Section 199A regulations, which were promulgated on January 18, 2019, make several clarifications to the rules regarding specified service trades or businesses (“SSTB”). Over certain taxable income thresholds, SSTBs are not eligible for the Section 199A deduction. The performance of services in the field of health is an SSTB and is defined in Section 1.199A-5(b)(2) of the final regulations as “the provision of medical services by individuals, such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, another similar healthcare professionals performing services in their capacity as such.” The operation of health clubs or health spas, payment processing, or the research, testing, manufacture and sales of pharmaceuticals or medical devices are not within the field of health.

Many commentators to the proposed regulations, including Williams Parker, noted that many of the services provided by skilled nursing facilities and assisted living facilities are unrelated to health care, including housing, meals, laundry, security, and socialization activities. Unfortunately, Treasury declined to issue specific guidance as to whether the owners of skilled nursing, assisted living, and similar facilities are performing services within the field of health, and noted that the issue “requires a facts and circumstances inquiry that is beyond the scope of these final regulations.”

However, the final regulations added an example in Section 1.199A-5(b)(3)(ii) of a senior housing facility that is not engaged in the field of health. In the example, the senior housing facility provides its residents with standard domestic services (including housing management and maintenance, meals, laundry, and entertainment), but all medical and health services (including skilled nursing, physical and occupational therapy, speech-language pathology, medications, medical supplies and equipment, and ambulance transportation) are provided through separate professional healthcare organizations. All of the health and medical services are billed directly by the healthcare providers to the senior citizens even though the services are provided at the facility. Unfortunately, the final regulations do not address a scenario where the facility invoices the senior citizens for the health and medical services on behalf of the healthcare providers.

View the final regulations.

This post is one in a series of posts on the 199A regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Safe Harbor Created for Rental Real Estate Activities and Section 199A Deduction, but Triple Net Leases are Excluded

Section 199A generally provides a 20 percent deduction for qualified business income of a trade or business. Many comments made with respect to the proposed Section 199A regulations focused on when rental real estate activities will constitute a trade or business, and thus be eligible for the Section 199A deduction. The final regulations generally define a trade or business by referencing Section 162, and the IRS acknowledged there is uncertainty regarding when rental real estate activities constitute a trade or business for purposes of Section 162. In connection with issuing the final Section 199A regulations on January 18, 2019, IRS issued notice 2019-07, which provides notice of a proposed revenue procedure detailing a proposed safe harbor under which rental real estate activities may be treated as a trade or business solely for purposes of Section 199A.

The notice provides that a “rental real estate enterprise” will qualify for the safe harbor if:

(a) Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

(b) For taxable years beginning prior to January 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise. For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed per year with respect to the real estate rental enterprise; and

(c) The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding (i) the hours of all services performed, (ii) a description of all services performed, (iii) dates on which such services are performed, and (iv) who performed the services. This contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.

The notice defines a rental real estate enterprise as an interest in real property (or multiple properties) held for the production of rents. The interest must be held directly or through an entity disregarded for income tax purposes. Commercial and residential real estate may not be part of the same enterprise. Real estate used by the taxpayer (including an owner or beneficiary of an owner of a pass-through entity that owns the real estate) as a residence for any part of the year under Section 280A is not eligible for the safe harbor.

Importantly, real estate leased under a triple net lease is also not eligible for the safe harbor. The notice provides that a triple net lease includes a lease arrangement that requires the tenant to pay taxes, fees, and insurance, and to be responsible for maintenance activities in addition to rent and utilities.

Rental services may be performed by the owner, employees, agents, and/or independent contractors of the owner. Rental services include (a) advertising to rent the real estate; (b) negotiating and executing leases; (c) verifying information contained in prospective tenant applications; (d) daily operation, maintenance, and repair of the property; (e) management of the real estate; (f) purchase of material; and (g) supervision of employees and independent contractors. Rental services do not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or operation reports; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.

In order to apply the safe harbor, the taxpayer claiming the Section 199A deduction must attach a signed statement (described in the notice) to its income tax return.

If a rental real estate activity fails to satisfy the safe harbor, it may still be treated as a trade or business for purposes of Section 199A if the activity otherwise qualifies as a trade or business under Section 162.

This post is one in a series of posts on the 199A regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

The Final Section 199A Regulations Eliminate the “80 Percent Cliff” for Property or Services Provided to a Commonly-Controlled SSTB

We previously blogged about the final Section 199A regulations confirming “cliff” treatment for the de minimis aggregation rule. However, the final regulations did delete a different cliff in the rules designed to defeat the so-called “crack and pack” strategy of segregating various activities of a specified service trade or business (“SSTB”) into SSTB and non-SSTB elements. Since the enactment of Section 199A as part of the Tax Cut and Jobs Act late in 2017, tax practitioners have been devising ways to take an SSTB, such as a physician group, and segregate the parts of the business that are a specified service trade or business from the parts that are not. For example, there has been speculation as to whether an S corporation operating a physician group that provides medical services (an SSTB), owns its building, and employs administrative and billing staff could be divided into three S corporations. S corporation 1 would provide medical services to patients, S corporation 2 would own the medical office building and lease it to S corporation 1, and S corporation 3 would employ the administrative and billing staff and provide its services to S corporation 1 in exchange for fees. The hope would be that the common owners of the three S corporations would be eligible for a 199A deduction with respect to S corporation 2 and S corporation 3 (they would generally not be eligible for a 199A deduction if all of the components of the physician group were contained within one entity).

The proposed regulations address this issue by providing that an SSTB includes any trade or business that provides 80% or more of its property or services to a specified service trade or business if there is 50% or more common ownership of the two trades or businesses. If a trade or business provides less than 80% of its property or services to a specified service trade or business that has 50% or more common ownership, then the portion of the trade or business providing property or services to the commonly-controlled business will be treated as part of the specified service trade or business. For example, if a dentist owns a dental practice and a building used in the practice in separate entities, and 40% of the real estate is leased to the dental practice and 60% of the real estate is leased to an unrelated tenant, then 40% of the real estate business will be treated as part of the dental SSTB, but the remaining 60% of the real estate business will not be treated as an SSTB. But, if 85% of the real estate was leased to the dental practice, then all of the real estate business (including the 15% leased to the unrelated tenant) would be treated as part of the dental SSTB. Thus, this rule creates an “80% cliff” for the unrelated portion of the real estate business.

In response to criticism of this 80% cliff, Treasury removed the 80 percent rule in Section 1.199A-5(c)(2) of the final regulations. Therefore, if a non-SSTB provides property or services to a 50 percent or more commonly controlled SSTB, the portion provided to the SSTB would be treated as a separate SSTB, and the remaining portion will be treated as a non-SSTB. Using the example above, if 85% of the real estate was leased to the dental practice, then only 85% of the real estate activity would be treated as an SSTB, and the other 15% of the real estate activity would be treated as a non-SSTB.

View the  final regulations.

This post is one in a series of posts on the 199A regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Final Section 199A Regulations Confirm Controversial “Cliff” Treatment in De Minimis Aggregation Rule but There Is a Parachute

The proposed Section 199A regulations provide a de minimis rule for trades or businesses with small amounts of gross receipts attributable to a specified service trade or business (“SSTB”). Specifically, the proposed regulations provide that if a non-SSTB has some relatively small elements that are SSTB services, then the SSTB services will not taint the treatment of the overall business. Specifically, the rule provides that for a trade or business with gross receipts of $25M or less for a taxable year, the trade or business will not be treated as an SSTB if less than 10 percent of its gross receipts are attributable to an SSTB. If the gross receipts of the trade or business are more than $25M, then the 10 percent threshold is dropped to 5 percent. For example, if an eye glass store had $10 million of total gross receipts, and $9.5 million of such gross receipts were attributable to the sale of eye glasses, and $0.5 million of the gross receipts were attributable to eye examinations performed by ophthalmologists, then the entire trade or business would be considered a non-SSTB for purposes of the Section 199A deduction.

We previously blogged that the proposed regulations did not address a scenario where, for example, $2 million of the gross receipts were attributable to eye examinations. In that scenario, we questioned whether the entire $10 million business would be treated as an SSTB, which would be a harsh result, especially for a taxpayer that is just over the de minimis threshold. A better answer, which commentators to the proposed regulations (including Williams Parker) proposed to IRS, would be that the eye glass and eye exam activities are treated as two separate trades or business for Section 199A purposes.

The final Section 199A regulations, which were promulgated on January 18, 2019, adopt both approaches. The example in Section 1.199A-5(c)(1)(iii)(A) of the final regulations confirms that the 5/10 percent de minimis threshold acts as a “cliff,” such that once the de minimis threshold is exceeded, all the income is considered income of an SSTB. However, the example in Section 1.199A-5(c)(1)(iii)(B) of the final regulations provides a parachute if the taxpayer can establish that its non-SSTB and SSTB operations are two separate trades or businesses (with separate books and records, invoicing, and employees). In that case, the non-SSTB trade or business would be eligible for the Section 199A deduction.

View the final regulations.

This post is one in a series of posts on the 199A regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Final Section 199A Regulations Make Key Changes to Aggregation Rules

The final Section 199A regulations, which were promulgated on January 18, 2019, clarified and changed a number of rules in the proposed regulations regarding when two or more trades or businesses may be aggregated.Under the aggregation rules in Treasury Regulation section 1.199A-4(b)(1), trades or business may generally be aggregated for purposes of Code section 199A if:

(i) there is 50 percent or more common ownership, directly or by attribution,

(ii) such ownership exists for a majority of the taxable year, including the last day of the taxable year,

(iii) items attributable to each trade or business is reported on returns with the same taxable year (ignoring short taxable years), and

(iv) the trades or businesses must satisfy at least two of the following (a) provide products, property, or services that are the same or customarily offered together, (b) share facilities or share significant centralized business elements, and (c) are operated in coordination with, or reliance upon, one or more of the businesses in the aggregated group (supply chain interdependencies, for example).

For purposes of determining 50 percent or more common ownership pursuant to (i) above, the proposed regulations created their own set of family attribution rules rather than relying upon existing family attribution rules in the Code. The final regulations follow the advice from several commentators, including Williams Parker, that the existing family attribution rules in Code section 267(b) should be used for determining common ownership.

The final regulations clarified the requirement that 50 percent or more common ownership must exist not only for a majority of the taxable year, but also on the last day of the taxable year.

For requirement (iv)(a) above, the proposed regulations require that the trades or businesses provide products and services that are the same or customarily offered together. As indicated in the preamble to the final regulations, Treasury changed this requirement based upon a comment from Williams Parker that the requirement should be changed to products or services. In addition, products or services was expanded to products, property (which includes real estate), or services.

The final regulations clarify that a specified service trade or business (“SSTB”) with de minims gross receipts below the thresholds described in section 1.199A-5(c)(1) is not treated as an SSTB, and therefore may be aggregated with non-SSTB trades or businesses under the aggregation rules.

Finally, the final regulations permit relevant pass-through entities (“RPEs”), not just individuals, to aggregate trades or business. RPEs can aggregate trades or businesses they operate directly or that are operated by lower-tier RPEs. The resulting aggregation must be reported by the RPE and all owners of the RPE. An individual or upper-tier RPE may not disaggregate the aggregated trades or businesses of a lower-tier RPE, but must instead maintain the lower-tier RPE’s aggregation, An individual or upper-tier RPE may aggregate additional trades or businesses with the lower-tier RPE’s aggregation if the aggregation rules are otherwise satisfied.

A link to the final regulations is here: https://www.irs.gov/pub/irs-drop/td-reg-107892-18.pdf.

This post is one in a series of posts regarding the final 199A Regulations. In case you missed them, catch up on our prior posts which explain some of the changes and review the UBIA rule.

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Final 199A Regulations Provide Favorable UBIA Rule for Section 721 and 351 Transactions

In calculating the Section 199A deduction, taxpayers must also determine the unadjusted basis immediately after acquisition (“UBIA”) of all qualified property of the trade or business. The UBIA serves as a limit on a taxpayer’s 20 percent Section 199A deduction. The proposed 199A regulations, promulgated in August 2018, provide that the UBIA of qualified property means the basis of that property on the placed in service date by the relevant pass-through entity (this is the tax partnership or S corporation conducting the qualified trade or business, which the regulations refer to as an “RPE”). Therefore, under the proposed regulations, the UBIA of qualified property contributed to a tax partnership in a Code section 721 transaction or to an S corporation in a Code section 351 transaction, would generally equal the contributor’s basis in the property at the time of contribution, rather than the contributor’s original basis in the property. Consequently, this treatment could result in a step-down in the UBIA of qualified property used in a trade or business at the time of contribution due only to a change in entity structure.

Commentators on the proposed regulations, including Williams Parker, urged Treasury to revise this regulation so that the UBIA of qualified property contributed to a tax partnership pursuant to Code section 721 or an S corporation pursuant to Code section 351 would be determined as of the date it was first placed in service by the contributing partner or shareholder. Fortunately, Treasury followed these suggestions and promulgated such a rule in Section 1.199A-2(c)(3)(iv) of the final Section 199A regulations, which were issued on January 18, 2019.

View the final regulations.

This post is one in a series of posts regarding the final 199A Regulations. In case you missed it, view our previous post explaining some of the changes. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Treasury Issues Highly-Anticipated Final 199A Regulations

The Treasury Department issued final regulations on January 18, 2019, on Code Section 199A and its 20 percent deduction against qualified business income. The final regulations make a number of significant changes to the proposed regulations, which were issued on August 16, 2018, and also provide a plethora of additional guidance. Some of the changes include (i) expansion of the aggregation rules for trades or businesses, (ii) addition of a rental real estate safe harbor, (iii) needed clarifications regarding the specified service trade or business rules, and (iv) favorable modifications to the determination of the basis of assets in computing the deduction.

We will be analyzing the 247-page final regulation package over the coming weeks and months and providing our insight to you in a series of blog posts.

View the final regulations.

View an advance version of Notice 2019-07, which contains a proposed revenue procedure regarding the rental real estate safe harbor.

Finally, view an advance version of Revenue Procedure 2019-11, which provides methods for calculating W-2 wages for purposes of the Code Section 199A deduction.

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

199A Regulations Address Specified Service Trades or Businesses with Other Business Elements

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.

View the proposed regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

199A Proposed Regulations Address Businesses with De Minimis Specified Service Trade or Business Elements

The proposed Section 199A regulations contain rules 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. These rules are contained in Section 1.199A-5(c)(1), and the SSTB issue is important because, with some exceptions based upon income level, income from an SSTB is not eligible for the Section 199A deduction.

Under these rules, if a non-SSTB has some relatively small elements that are SSTB services, then the SSTB services will not taint the treatment of the overall business. Specifically, the rule provides that for a trade or business with gross receipts of $25M or less for a taxable year (before application of the aggregation rules), the trade or business will not be treated as an SSTB if less than 10% of its gross receipts are attributable to an SSTB. If the gross receipts of the trade or business are more than $25M, then the 10% threshold is dropped to 5%. For example, if an eye glass store had $10M total gross receipts, and $9.5M of such gross receipts were attributable to the sale of eye glasses, and $0.5M of the gross receipts attributable to eye examinations performed by ophthalmologists, then the entire trade or business would be considered a non-SSTB for purposes of the Section 199A deduction.

The regulations do not address a scenario where, for example, $2M of the gross receipts were attributable to eye examinations. In that scenario, will the entire $10M business be treated as an SSTB? That does not seem like it should be the correct answer. A better answer would be that the eye glass and eye exam activities are treated as two separate trades or business for Section 199A purposes.

In interesting scenario is if the individual taxpayer operated the eye glass ($9.5M of gross receipts) and eye exam ($0.50M of gross receipts) businesses in separate entities. In that case, the eye glass business would be a non-SSTB, and the eye exam business would be an SSTB (and thus not eligible for the Section 199A deduction). However, a tax planning opportunity may exist to merge the two entities, and then take advantage of the aggregation rule to “cleanse” the eye exam business of its SSTB taint by having it become a de minimis part of the eye glass business under the aggregation rules.

View the proposed regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

199A Proposed Regulations Address the ”Crack-and-Pack” Strategy

Since the enactment of Section 199A as part of the Tax Cut and Jobs Act late last year, tax practitioners have been devising ways to take a specified service trade or business, such as a physician group, and segregate the parts of the business that are a specified service trade or business from the parts that are not. For example, there has been speculation as to whether an S corporation operating a physician group that provides medical services (which is a specified service trade or business), owns its building, and employs administrative and billing staff could be divided into three S corporations. S corporation 1 would provide medical services to patients, S corporation 2 would own the medical office building and lease it to S corporation 1, and S corporation 3 would employ the administrative and billing staff and provide its services to S corporation 1 in exchange for fees. The hope would be that the common owners of the three S corporations would be eligible for a 199A deduction with respect to S corporation 2 and S corporation 3 (they would generally not be eligible for a 199A deduction if all of the components of the physician group were contained within one entity).

The proposed 199A regulations provide rules addressing this issue in Section 1.199A-5(c)(2). These rules provide that a specified service trade or business includes any trade or business that provides 80% or more of its property or services to a specified service trade or business if there is 50% or more common ownership (using the related party rules in Sections 267(b) and 707(b)) of the two trades or businesses. If a trade or business provides less than 80% of its property or services to a specified service trade or business that has 50% or more common ownership, then the portion of the trade or business providing property or services to the commonly-controlled business will be treated as part of the specified service trade or business. For example, if a dentist owns a dental practice and a building used in the practice in separate entities, and 40% of the real estate is leased to the dental practice and 60% of the real estate is leased to an unrelated tenant, then 40% of the real estate business will be treated as part of the dental specified service trade or business. But, if 80% of the real estate was leased to the dental practice, then all of the real estate would be treated as part of the dental specified service trade or business.

View the proposed regulations. 

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043