This is the seventh installment of our monthly tax blog on the Tax Cuts and Jobs Act. In our third installment we provided an overview of the deduction. The fifth installment provided more detail for deductions on rental property income. If you are a business owner, you have likely heard about QBI and wondered, “Will I qualify?” Read on to discover whether you might be able to deduct up to 20% of your business income on your 2018 taxes.
In this entry, we will expand on which businesses qualify for the deduction. Owners of “specified service trades or businesses” (SSTBs) will not be allowed to take the 20% deduction if taxable income is above a threshold amount. The initial release of the Tax Cuts and Jobs Act created concern for some taxpayers because it potentially included a broad range of businesses in the definition of an SSTB. An IRS update released in August of 2018 included guidance designed to address those concerns. Below, we will explain which types of business activity will qualify for the deduction under the newly clarified definition of SSTBs.
Overview of the Qualified Business Income Deduction
In case you are not familiar with our past entries, we will first provide a brief overview of how the Qualified Business Income Deduction works. This deduction will allow the owners of sole proprietorships (Schedule C or Schedule E), partnerships, and S Corporations to take up to a 20% deduction on qualified business income. Qualified business income (QBI) is the income directly connected to the operations of a business, so it does not include investment-type income such as dividends and capital gains. If you qualify to take the full deduction, you would pay tax on only 80% of your income from the trade or business rather than 100%. This deduction is available regardless of whether you itemize deductions or take the standard deduction.
For more information on major exceptions and limitations related to this deduction, see our blog entry titled “Planning for Your Taxes in 2018 part 3: Section 199A or the Qualified Business Income Deduction.”
Specified Service Trades or Businesses
Which Professions are Specifically Included in the Definition of an SSTB?
As outlined in our previous blog entry summarizing the deduction, taxpayers earning income from “specified service trades or businesses” will not qualify for any portion of the Section 199A deduction if taxable income is above $207,500 (single) or $415,000 (married filing jointly). This includes businesses in the fields of health, law, accounting, consulting, brokerage or financial services, performing arts, and athletics.
The updated regulations provide more detailed guidance on which jobs within a field are disqualified. For instance, the IRS specifies that in the health field, a doctor would be disqualified from taking the deduction but a manufacturer of medical equipment would not.
The IRS Update: Which Professions and Activities Will Qualify for the Deduction?
First, we note that the updated regulations specifically state that bankers, real estate brokers, real estate managers, architects, and engineers are not engaged in a specified service business. Taxpayers in these professions will qualify for the 20% deduction, even if taxable income exceeds the thresholds mentioned above.
However, the aspect of specified service businesses that was most troubling to tax professionals in the original statute was a “catch-all” stating that a specified service business is “any trade or business where the principal asset…is the reputation or skill of 1 or more of its owners or employees.” The concern with this definition was that any taxpayers outside of the typically included professions (law, health, etc.) could fall under this definition. For example, could a famous author whose skill drives the sales of their books be included? What about a sole proprietor craftsman who is well known locally for building beautiful custom furniture?
The IRS has now issued more specific guidance on when a person’s “skill or reputation” will cause income to be treated as specified service income. For people who work outside of specifically listed professions, essentially only income received from marketing your reputation will be included as specified service income. This includes compensation from: licensing your identity (name, signature, image, or voice); making media or event appearances; and endorsing products.
In our example of the famous author, he or she would not have specified service income from selling novels. However, if the author received a fee for appearing at a meet-and-greet, the fee would be ineligible for the deduction. Similarly, assuming the local craftsman in our example only earns income from selling furniture, it would not be classified as specified service income.
The bottom line on this issue is that even if your business income is driven largely by your skill or reputation, unless you are in a specifically listed profession or monetize your reputation through licensing, endorsements, or appearances, you will not be ruled ineligible for the deduction.
If you have any questions concerning the Qualified Business Income Deduction, please speak with your advisor or reach out to us at Isler CPA by calling 541-342-5161.