Tag Archives: non-SSTB

The Final Section 199A Regulations Eliminate Anti-Abuse Rule from the Proposed Regulations

The proposed Section 199A regulations provide anti-abuse rules to limit the ability of taxpayers to separate a specified service trade or business (“SSTB”) from a non-SSTB. One of those rules provides that if a non-SSTB has both 50 percent or more common ownership with an SSTB and shared expenses with the SSTB, then the non-SSTB will be considered incidental to, and part of, the SSTB if the gross receipts of the non-SSTB represent 5 percent or less of the total combined gross receipts of the non-SSTB and SSTB.

The proposed regulations provide an example of this rule 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.

Treasury received numerous comments, including from Williams Parker, critical of this rule for various reasons, including uncertainty as to the meaning of shared expenses and how to allocate gross receipts, and also the negative impact to owners of SSTB’s that create start-up businesses that are non-SSTBs. Thankfully, in response to these comments, Treasury eliminated this so-called “incidental rule” from the final Section 199A regulations.

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

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