Under the 2017 Tax Cuts and Jobs Act, Congress enacted a new Section 199A 20% profit deduction for owners of pass-through businesses, and which include Subchapter S corporations, LLCs, sole proprietorships, and even certain trusts. Section 199A is intended to provide a deduction to owners of these pass-through business entities who do not otherwise benefit from the new 21% flat tax Congress has given to corporations under the new tax law. While Section 199A is intended to benefit these generally smaller types of business entities and their owners, the new tax law is riddled with complexity and exceptions, and so that many well-meaning small business owners may not receive the deduction, or at least its full amount.
For most pass-through business owners, the deduction is the lesser of (1) the “combined qualified business income” of the taxpayer, or (2) 20% of the excess of taxable income over the sum of any net capital gain. The term “combined qualified business income” is then defined as the lesser of (1) 20% of the business owner’s “qualified business income” (QBI) or (2) the greater of (A) 50% of the W-2 wages of the business allocable to the owner or (B) 25% of the W-2 wages of the business plus 2.5% of the unadjusted tax basis in property of the business (generally the original cost of certain depreciable assets) allocable to the business owner.
The 20% pass-through deduction is not applicable generally to businesses that provide services, such as doctors, lawyers, accountants, athletes, stock brokers, and others, except where the service provider has taxable income of less than $315,000 (married) or $157,500 (individual). The benefit to these service providers is phased out over these income thresholds (another $100,000 for married filers and $50,000 for individuals), so that where a married filer has over $415,000 in taxable income or an individual filer has over $217,500 in taxable income, the 20% deduction is lost for the service provider’s business. Thus, there is no benefit here to businesses of higher-paid service providers.
The IRS recently issued final regulations under Section 199A on January 18, 2019, following the issuance of proposed regulations in August 2018. In the proposed regulations, and now in the final regulations, the IRS has incorporated the definition of a “Specified Service Trade or Business” (SSTB), and where none of the income from such a business will qualify for the Section 199A deduction. An SSTB can be a defined and “listed” trade or business involving the performance of services in specific fields, including health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investment/investment management, trading, dealing in securities/commodities, and any “trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its owners or employees” (thankfully, limited in scope in the final regulations).
In the area of health, the final regulations define these services to mean “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 performance of services in the field of health does not include the provision of services not directly related to a medical services field, even though the services provided may purportedly relate to the health of the service recipient.”
Owners of assisted and senior living facilities and homes, including skilled nursing facilities have been uncertain about the scope of new Section 199A, and whether this new deduction may apply to these businesses operating through pass-thru entities (e.g. S corporations, partnerships/LLCs). The uncertainly is compounded because these facilities provide many different types of services, and which can include certain medical-related services.
In the final regulations, the IRS has offered a number of new examples, and where the IRS believes that certain businesses may be an SSTB or not. This includes businesses in the health area. One important example applies to a senior living facility, and which provides:
X is the operator of a residential facility that provides a variety of services to senior citizens who reside on campus. For residents, X offers standard domestic services including housing management and maintenance, meals, laundry, entertainment, and other similar services. In addition, X contracts with local professional healthcare organizations to offer residents a range of medical and health services provided at the facility, including skilled nursing care, physical and occupational therapy, speech-language pathology services, medical social services, medications, medical supplies and equipment used in the facility, ambulance transportation to the nearest supplier of needed services, and dietary counseling. X receives all of its income from residents for the costs associated with residing at the facility. Any health and medical services are billed directly by the healthcare providers to the senior citizens for those professional healthcare services even though those services are provided at the facility. X does not perform services in the field of health within the meaning of section 199A(d)(2) and paragraphs (b)(1)(i) and (b)(2)(ii) of this section.
The guidance provided by the IRS in its example in the final regulations is certainly helpful to owners of assisted/senior living facilities. However, the guidance makes clear that the business is not an SSTB in the example because the specific “residential” services it provides and charges to its residents are not considered “health-related”; for the “health and medical services”, the facility contracts with healthcare professionals who provide and separately charge the residents for these services.
Owners of assisted and senior living facilities which operate their business through a pass-thru business entity may qualify for the new Section 199A deduction. However, with the final regulations, and including specific examples, the IRS is seeking to define the limits of what services may be provided at these facilities in order to qualify. Under the final regulations only strictly “residential-related” services may be provided and charged by the owner, and not health-related or medical services. If health-related and medical services are provided to residents, while the services may be provided at the facility, they must be provided and charged by separate healthcare professionals and providers in order for the business to not be considered a SSTB and to potentially qualify for the deduction.