QBI Deduction: Demystifying the Service Business Limitation
posted Nov 29, 2018 by Joe Tamburo, CPA in the Global Tax Blog
Many professional service providers — such as lawyers, doctors and architects — mistakenly believe they’re automatically ineligible for the new deduction for qualified business income (QBI) under the Tax Cuts and Jobs Act (TCJA). While there is a limitation for specified service trades or businesses (SSTBs), it doesn’t necessarily apply to all service providers. Are you eligible?
Pass-Throughs vs. C Corps
First and foremost, the QBI deduction is available only to owners of pass-through entities, such as sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations. If your service business is structured as a C corporation or a personal service corporation (PSC), your federal income tax rate will be a flat 21% for tax years beginning after 2017. (Before the TCJA, PSCs were taxed at a higher rate than other C corporations.)
If your service business operates as a C corporation or PCS, you’re ineligible for the QBI deduction. If your service business operates as a pass-through entity, there’s a chance that you might qualify for the deduction.
Definition of SSTB
In general, the TCJA limits QBI deductions from service businesses. Specifically, Internal Revenue Code Sec. 199A uses the acronym “SSTB” to refer to any trade or business involving the performance of services in the following fields:
- Health, law, accounting and actuarial science,
- Financial, brokerage, investing and investment management services,
- Dealing in securities, partnership interests or commodities, and
- Athletics and performing arts.
Engineers and architects are specifically excluded from the definition of SSTB. However, the definition contains the following “catchall” phrase: “any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.” Recent IRS proposed regulations clarify that the limitation applies to any service business that receives fees, compensation or other income for:
- Endorsing products or services,
- Using an individual’s image, likeness, name, signature, voice, trademark or any other symbol associated with that individual’s identity, or
- Appearing at an event or on radio, television, or another media format.
If your business qualifies as an SSTB under the law, there’s still a chance that you may qualify for the QBI deduction, depending on your income level and the nature of your operations.
The limitation does not apply when the owner of an SSTB has taxable income (calculated before any QBI deduction) below $157,501 or $315,001 for a married joint-filer. Owners of pass-through SSTBs with income below this threshold may claim the full 20% deduction.
The limitation is in full effect once owner’s taxable income exceeds $207,500, or $415,000 for a married joint-filer. Owners of pass-through SSTBs with income above this amount are ineligible for the QBI deduction.
Owners between these two amounts may be eligible for a partial deduction. The calculations are even more complicated when the deduction is affected by both the SSTB limitation rule and the other limitations based on W-2 wages and the basis of qualified property.
De Minimis Rule
If your business provides both products and services, the proposed regulations provide a helpful de minimis rule. The limitation doesn’t apply if 1) your business’s gross receipts are $25 million or less for the tax year, and 2) less than 10% of its gross receipts are attributable to performing services. The applicable percentage drops from 10% to 5% if your business’s gross receipts are greater than $25 million.
Some clients have asked: “Can you break out revenue from selling products to qualify for a partial QBI deduction on nonservice sales?” For example, some doctors want to claim a QBI deduction from selling supplemental products to patients (like optometrists who sell eyewear or podiatrists who sell orthotic shoe inserts. Unfortunately, the proposed regulations include an antiabuse rule to prevent service business owners from separating out parts of what would otherwise be an integrated SSTB.
The rules for claiming the QBI deduction are long and complex — and many restrictions apply. Our tax professionals can help you sort through the details of this tax break, including the SSTB limitation.
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