One of the more controversial aspects of the recent tax reform is that while corporations received a generous rate reduction (to 21%), rates generally remained higher for sole proprietors and owners of passthrough businesses.
So Congress included a workaround: A deduction of up to 20 percent for those individual taxpayers to bring their rate down. The new Section 199A deduction, which eligible taxpayers can start claiming on their 2018 federal income tax returns, is generally available to sole proprietors and business owners with pass-through businesses; including partnerships, limited liability companies (LLCs) and S corporations. The deduction also applies to certain trusts and estates.
That seems like good news for many individual taxpayers unless they are considered to be engaged in a Specified Service Trade or Business (SSTB).
Broadly speaking, an SSTB is any business involving the performance of services in health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading or dealing in securities, partnership interests or commodities or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.”
In other words, if the success of your business or practice depends on you and not on something that you sell, you could very well be left out of the deduction. We have highlighted a few of the key takeaways from the proposed §1.199A-5 regulations aimed to clarify the SSTB definition:
1. THE “REPUTATION OR SKILL” CATEGORY MAY NOT BE SO BROAD AFTER ALL.
The proposed regulations have provided a lot more insight into the definition of SSTB, especially when it comes to the category of “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.”
Based on the definition and examples in the proposed regulations, this category may not be so broad after all and has been defined to be much less than it sounds. Per Proposed Regulation §1.199A-5(b)(2)(xiv), this SSTB category means any trade or business that consists of any of the following (or any combination thereof):
A. A trade or business in which a person receives fees, compensation, or other income for endorsing products or services,
B. A trade or business in which a person licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity,
C. Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
2. CONSULTING MAY ALSO BE A LOT MORE LIMITED THAN ORIGINALLY THOUGHT.
Per Proposed Regulation §1.199A-5(b) (2)(vii), the performance of services in the field of consulting refers to the provision of professional advice and counsel to assist clients in achieving goals and solving problems.
The subsection adds that “ the performance of services in the field of consulting does not include the performance of services other than advice and counsel” and that the “performance of services in the field of consulting does not include the performance of consulting services embedded in, or ancillary to, the sale of goods or performance of services on behalf of a trade or business that is otherwise not an SSTB (such as typical services provided by a building contractor) if there is no separate payment for the consulting services.”
3. THE PROPOSED REGULATIONS MAKE SEVERAL FRIENDLY CARVE-OUTS FOR REAL ESTATE RELATED ACTIVITIES.
The proposed regulations make specific exclusions for real estate agents, brokers and real estate/property management companies.
Under Proposed Regulation §1.199A-5(b) (2)(x), the performance of services in the field of brokerage services does not include services provided by real estate agents and brokers.
Under Proposed Regulation §1.199A- 5(b)(2)(xi), the performance of services of investing and investment management does not include entities that directly manage real property.
The proposed regulations and examples do help to clarify the SSTB definition somewhat. Although some business owners may now breathe a sigh of relief, others may still be left with unanswered questions. With the help of their tax professionals, these business owners will no doubt need to navigate and interpret the proposed regulations themselves to find the answers.
Jonathan Siao (Tax Partner); Julia Chan (Senior Tax Manager); and Steven Diaz (Senior Tax Accountant) are with HCVT, the 5th largest CPA firm based in Los Angeles. Learn more at hcvt.com.
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