Specified Service Trades and Businesses Excluded from Tax Act’s 20% Pass-through Deduction

For Many Taxpayers, Uncertainty Still Prevails About Their Eligibility for the Pass-through

The Tax Cuts and Jobs Act introduced a new deduction for pass-through entities equal to 20% of their qualified trade or business income. However, if you are a “specified service trade or business” and your taxable income is over $157,500 ($315,000 in the case of a joint return) your deduction is limited and once your income is over $207,500 ($415,000 in the case of a joint return) you completely lose the deduction.

What is a “Specified Service Trade or Business” Under the Tax Cuts and Jobs Act?

In general, under IRC Section 1202(e)(3)(A), the term “specified service trade or business” is any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.

As the definition is well defined, you should know whether your business is or isn’t a “specified service trade or business,” but taxpayer confusion is high. While section 1202(e)(3)(A) is not new, there is not a lot of additional guidance available to help clarify which types of businesses are and aren’t included in the definition.  

I am going to briefly discuss what currently is out there, starting with a recommendation that you read our recent post, “Are You Eligible for the New Tax Act’s 20% Deduction?”

John P. Owen v. Commissioner

In 2012 there was a tax court case, John P. Owen v. Commissioner, that raised the issue of whether or not Mr. Owen’s business which sold prepaid legal service policies, including estate planning services,  fell under the definition of section 1202(e)(3)(A).  

The IRS argued that one of the principal assets of Mr. Owen’s business was the skill of Mr. Owen. The tax court disagreed, claiming that the principal asset of the company was the training and organizational structure stating “after all, it was the independent contractors, including Mr. Owen in his commission sales tax hat who sold the policies that earned the premiums, not Mr. Owen in his personal capacity.”  

This is a very taxpayer-friendly ruling and potentially opens the door for other taxpayers who identify a training and organizational structure as the principal asset qualifying them for the new 20% deduction from qualified business income... until further guidance is issued by the IRS.

Private Letter Ruling 2017-17010

In 2017 the IRS issued Private Letter Ruling 2017-17010 where the developer of a tool used to provide complete and timely information to healthcare providers was deemed to not be a trade or business described in section 1202(e)(3)(A). The IRS pointed to a number of factors in making their determination including:

• The company does not discuss diagnosis or treatment with the healthcare providers.
• The company’s only contact with patients was billing related when insurers did not cover all of the laboratory costs.
• The skills the employees brought to the Company were not useful in performing testing as they had to be trained for up to a year to perform such testing and the skills they develop at the Company are not useful to other employers.
• None of the Company’s revenue is earned in connection with patients’ medical care.  
• Other than the laboratory director, none of the other employees were classified as healthcare professionals for state licensing requirements.

This was another taxpayer-friendly decision and gives a number of factors to consider when determining whether or not your business falls into this definition.  

Contact Freed Maxick for Updates and Guidance

The situations and circumstances discussed above gives us a handful of factors to consider but leaves numerous businesses and taxpayers without clear guidance. Unless the IRS releases regulations or additional guidance, there will be many businesses who cannot definitively determine whether or not they are a “specified service trade or business.”  

The tax team at Freed Maxick is available to discuss your situation and brainstorm opportunities to help you capitalize on all available Federal and New York State tax credits, incentives and minimization opportunities. Contact (name) at (phone) to schedule a complimentary discussion, or reach us via the form, here, to schedule a Tax Situation Review.