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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