The IRS issued 184 pages of regulations clarifying the new 20 percent Section 199A deduction. One big deal in the new regulations is a significant narrowing of the out-of favor reputation and skill group. Other big deals are the clear definitions that apply to various professions. The IRS did many businesses a huge favor with these new regulations.
If you operate an out-of-favor business (known in the law as a “specified service trade or business”) and your taxable income is more than $207,500 (single) or $415,000 (married, filing jointly), your Section 199A deduction is easy to compute. It’s zero.
OK, So Who Is Out of Favor?
This out-of-favor specified service trade or business group includes any trade or business
- involving the performance of services in the fields of health, law, consulting, athletics, financial services, and brokerage services; or
- where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or
- that involves the performance of services that consist of investing and investment management trading or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities [Sections 475(c)(2) and 475(e)(2), respectively].
As you can see from the above, the tax code is a little vague on the requirements for who is and who is not in an out-of-favor specified service business. But now, thanks to new IRS proposed Section 199A regulations, we have some real clarity. Below, we first go through the clarifications for each of the above three groups one by one.
Group 1: Certain Professions
Health. The out-of-favor specified health service business means a business where individuals render services as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar health care professionals who provide medical services directly to a patient. The health group does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers, payment processing, or the research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.
Law. An out-of-favor specified service business in the field of law is a business where individuals perform services in their capacities as lawyers, paralegals, legal arbitrators, mediators, and similar professionals. The law group does not include services that do not require skills unique to the field of law, such as printers, delivery services, or stenography services.
Accounting. The performance of services in the field of accounting means the rendering of services by individuals as accountants, enrolled agents, return preparers, financial auditors, and other similar professionals performing services in their capacity as such.
Actuarial Science. The actuarial group means businesses where individuals provide services as actuaries and other similar professionals performing services in their capacity as such.
Performing Arts. The performance of services in the field of the performing arts means the performance of services by individuals who participate in the creation of performing arts, such as actors, singers, musicians, entertainers, directors, and similar professionals performing services in their capacity as such. The performing arts group does not include services that don’t require skills unique to the creation of performing arts, such as the maintenance and operation of performing arts facilities and services by people who broadcast or disseminate video or audio of performing arts to the public.
Consulting. In the field of consulting, the out-of-favor specified service business includes providing professional advice and counsel to clients to assist clients in achieving goals and solving problems, including government lobbying. The consulting group does not include services other than advice and counsel, such as sales or economically similar services or the provision of
training and educational courses or consulting services embedded in or ancillary to the sale of goods or performance of services on behalf of a trade or business that is otherwise not an out-of-favor business (such as typical services provided by a building contractor) if there is no separate payment for the consulting services.
Athletics. The performance of services in the field of athletics means the performance of services by individuals who participate in athletic competition, such as athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing.
The athletics group does not include services that don’t require skills unique to athletic competition, such as the maintenance and operation of athletic events facilities and services by people who broadcast or disseminate video or audio of athletic events to the public.
Financial Services. The performance of services in the field of financial services means the provision of financial services to clients, including managing wealth; advising clients with respect to finances; developing retirement plans; developing wealth transition plans; providing advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in Title 11 or similar cases); raising financial capital by underwriting; or acting as a client’s agent in the issuance of securities and similar services. The financial services group includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals performing services in their capacity as such.
Brokerage services. The performance of services in the field of brokerage services includes services in which a person arranges transactions between a buyer and a seller with respect to securities for a commission or fee. This includes services provided by stockbrokers and other similar professionals. The out-of-favor brokerage group does not include real estate agents or
brokers or insurance agents or brokers.
Group 2: Primary Asset Is Reputation and/or Skill
If you were not in one of the named groups above, you likely worried about being in a reputation and/or skill of owners and/or employees out-of-favor specified service business. If you were worried, you joined a large group of worried businesses, because many businesses depend on reputation and/or skill for success.
For example, the National Association of Realtors believed real estate agents fell into this out-of-favor category.
Don’t worry, be happy. The IRS has come to the rescue by regulating the draconian reputation and/or skill provision down to almost nothing. The reputation and/or skill out-of-favor specified service business includes you if you
- receive fees, compensation, or other income for endorsing products or services;
- license or receive fees, compensation, or other income for the use of your image, likeness, name, signature, voice, trademark, or any other symbols associated with your identity; or
- receive fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
Example. Harry is a well-known chef and the sole owner of multiple restaurants, each of which is a single-member LLC—disregarded tax entities that are taxed as proprietorships. Due to Harry’s skill and reputation as a chef, he receives an endorsement fee of $500,000 for the use of his name on a line of cooking utensils and cookware. Harry’s restaurant business is not an out-of-favor business, but his endorsement fee is an out-of-favor specified service business.
Group 3: Investing, Trading, Dealing
Investment and investment management services. The performance of services that consist of investing and investment management refers to an out-of-favor specified trade or business involving the receipt of fees for providing investing, asset management, or investment management services, including providing advice with respect to buying and selling investments. The performance of services of investing and investment management does not include directly managing real property.
Final Thoughts
The original statute with its owner and/or employee reputation or skill read broadly could have applied the out-of-favor specified service business designation to almost any business. Thank goodness the IRS and its new Section 199A regulations made good sense out of what could have been a huge mess. Now, with the new IRS regulations, you can more easily identify which businesses are in favor and which are not. You even have clarity if you perform services in the fields of health, law, consulting, athletics, financial services, or brokerage services. Make sure you read the “don’t worry, be happy” section above that details how the new regulations define an out-of-favor business based on the reputation or skill of one or more employees or owners.
For more details and an easy way to fall asleep, here is a link to the details of the Proposed Rule by the IRS in the Federal Register.