QBI: Final Section 199A Regulations Revealed
On January 18, 2019, the IRS released the final regulations pertaining to the new Section 199A 20% Qualified Business Income Deduction. Rather than provide any major functional changes in the deduction, the final regulations served to answer questions concerning the proposed regulations (issued in August 2018) and take the resulting practitioner comments and suggestions into consideration. We have highlighted a few of the noteworthy items that were revealed by the final regulations:
Rental Real Estate Activities
One of the lingering questions left over from the proposed regulations was when a rental real estate activity would rise to the level of a trade or business, and thus create income eligible for the 20% deduction. While this question is still not answered entirely, the IRS did publish Notice 2019-07 that provides a safe harbor for taxpayers that own rental real estate activities where at least 250 hours of management level services are provided by someone (unrelated property managers count) during the year, keep books and records, and keep time/activity logs will rise to the level of a trade or business.
Taxpayers may aggregate their properties provided they are of the same nature in terms of commercial or residential, and the direct property owner is the same taxpayer. Thus, if I own a residential rental property directly and also own a 10% interest in a multi-family partnership, I may not aggregate these hours for purposes of meeting the safe harbor. Triple net leases are disqualified from using this safe harbor, and likely will have a difficult time rising to the level of a trade or business outside of “self-rental” situations where the property is leased to a related trade or business. Since this is merely a safe harbor, activity below this threshold may still qualify as a trade or business so long as the taxpayer or entity be involved with continuity and regularity from a management perspective, as investor level participation is not applicable in determining this designation.
Mixed Service and Non-Service Entities
Under Section 199A, certain professional service industries such as health, law, accounting and financial services stand to have their 20% deductions limited or even eliminated at certain income levels - $315,000 taxable income in 2018 if filing jointly. The final regulations provide guidance in situations where an entity may contain both service and non-service trades or businesses.
One key takeaway here is that the final regulations do not wish to treat single trades or businesses “pro-rata” between service and non-service. If a trade or business has $25 million or less in gross receipts, and less than 10% of its gross receipts are classified as being from a specified service, then the entire trade or business will not be treated as a specified service trade or business. If greater than 10% of the receipts are considered that of a specified service, then the entire trade or business will be treated as such. Due to this threshold, it is extremely important for entities that contain service and non-service businesses to clearly segregate their businesses by keeping separate books and records, invoicing separately, having employees work in roles defined for either the service or non-service piece and taking other steps to show the IRS that the entity clearly has two separate businesses taking place.
Relaxed Definition for Medical Services
One of the specified service trades or businesses that stand to have their Section 199A Deduction limited are those in the medical field. The final regulations define the medical field as “the provision of medical services by individuals such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals performing services in their capacity as such.”
The final regulations provide an example where a business owner owns and operates specialty surgery centers that manage the facility operations and perform administrative functions. The surgery center does not employ physicians, nurses, or medical assistants, but enters into agreements with organizations that directly perform the procedures. Patients receive a bill from the surgery center and from the medical care provider. The final regulations have taken the stance that the surgery center is not performing services in the field of health, and therefore is not a specified service trade or business. Other relaxed definitions involve the sale of pharmaceutical products by a retail pharmacy and the operation of a residential facility where they too may be able to exclude themselves from the specified service trade or business definition.
Tyler Engstrom | 01/29/2019