Which Businesses Are Considered a Specified Service Trade or Business?
As part of the Tax Cuts and Jobs Act, a new deduction was created as an offset to “qualified business income” (QBI) designed to reduce the tax burden of business owners. This new section of the tax law, while favorable to many sole proprietors and owners of pass-through entities, brings with it several limitations that may reduce or eliminate the potential benefit for certain business owners. The first of these limitations is determining whether your business is a “qualified trade or business”. This term was broadly defined under the new law to be any trade or business that is not a “specified service trade or business” (SSTB) or those performing services as an employee.
What is a Specified Service or Trade Business (SSTB)?
Included in the Internal Revenue Code’s definition of an SSTB were many professional service businesses (accounting, legal, health, actuarial science, performing arts, financial and brokerage services) while excluding others (architecture and engineering) and specific financial services of investing and investment management, trading or dealing in securities, partnership interests or commodities. Additionally, there appeared to be two catchalls in the definition designed to capture most service companies with consulting and “any trade or business where the principal asset is the reputation or skill of 1 or more of its employees or owners”. The IRS has now issued proposed tax regulations to further define SSTB’s and surprisingly made the definition significantly narrower than expected. The balance of this article will focus on a number of the favorable definitions provided by the new proposed tax regulations.
Examples of Specified Service or Trade Businesses
Services in the field of health are defined only to include healthcare professionals who provide medical services directly to a patient. Now excluded from being an SSTB are health clubs and similar facilities, medical research and testing services, and the manufacturing and sales of pharmaceuticals and medical devices. Additionally, other businesses supporting healthcare professionals such as medical billing services would be excluded from the definition of an SSTB.
Specified service or trade businesses in the field of brokerage services have been narrowly defined to include only services relating to the sale of securities for a commission or fee. This opens the door for real estate agents and brokers along with insurance agents and brokers to benefit from the QBI deduction. Additionally, the definition of investing and investment management appears to be focused mainly on financial investments as the regulation has specifically excluded real estate management from being an SSTB under investment management.
Consulting is defined as the provision of professional advice and counsel to clients in achieving goals and solving problems. It also includes services regarding advocacy with the intention of influencing government officials. Specifically excluded are providing training and educational courses along with sales and economically similar services. Determining which businesses qualify for this type of SSTB will require a review of the facts and circumstances along with professional judgment as there is room for interpretation as to what services will constitute consulting. The IRS does provide an example of a business which licenses software and evaluates its customer’s software needs and advises the customer on the selection of the software product as part of a flat fee charged for the software licenses. The IRS indicated that this business was not an SSTB.
Perhaps the most surprising definition included in the regulations is that for “any trade or business where the principal asset is the reputation or skill of 1 or more of its employees or owners”. This once expected catchall provision has been defined to only include fees for endorsing products, use of a person’s image, name, voice, trademark or other similar symbols associated with the individual, and appearances. This type of specified service or trade business now seems to be focused on fees earned by entertainers and celebrities as opposed to other traditional trades or businesses.
Anti-abuse Provisions in New Tax Law
As part of this guidance, the IRS did provide a couple of anti-abuse provisions to prevent taxpayers from incorrectly trying to take advantage of the tax law. The first relates to a common question I am asked at networking types of functions where an employee now desires to be treated as an independent contractor to take advantage of this new tax deduction. The regulations provide that former employees are presumed to still be employees even if subsequently treated as an independent contractor. The IRS provides a number of tests and factors to consider if a worker is an independent contractor or employee which should be considered by an employer before changing a worker’s classification.
The second anti-abuse provision relates to related party businesses. Here the IRS has stated that if a business that otherwise wouldn’t be considered an SSTB has 50 percent or more common ownership with an SSTB (including related parties) and is providing substantially all of its property or services to the related SSTB it will be considered an SSTB. Substantially all is defined to be 80 percent or more of its total property or services to the related SSTB. This is designed to prevent taxpayers from shifting income to non-SSTB businesses by adjusting the purchase price on related party sales to take advantage of the tax break.
Overall, this proposed tax regulation was a welcome one for many service providers who were expecting to not qualify for the QBI tax break. Unfortunately, many professional service providers are still generally excluded unless they qualify as a small business by being below the taxable income threshold ($415,000 for married filing joint taxpayers/$207,500 for others). It is important to note that these are proposed tax regulations and are still subject to change when the final regulations are issued.
