We have been monitoring and reporting on tax reform for several months, including one of the most complicated areas of the new law – Section 199A, commonly known as the 20% pass-through deduction.
Final regulations were announced last month and are effective immediately. However, taxpayers may rely on the proposed regulations for taxable years ending in the 2018 calendar year. This means that healthcare professionals need to consult with tax advisers soon to determine whether the proposed or final rules are beneficial for 2018 tax returns.
While we have summarized some of the more pertinent changes for healthcare entities here, determining the impact of these rules on your pass-through business will require a discussion with your tax adviser about your personal situation.
Are You In a Specified Service Trade or Business (SSTB)?
Section 199A provides a deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. However, most high-earning healthcare professionals won’t benefit from the deduction, since the field of health is listed as an SSTB.
Now, the pass-through deduction is out of reach for even more healthcare professionals. In the final regulations, the IRS removed language that required an SSTB to provide medical services directly to the patient, opening up radiologists and other similar service providers to being swept up in the definition.
In general, the IRS declined to provide bright lines on whether specific trades or businesses would constitute SSTBs, taking the position that such determinations require consideration of the facts and circumstances of each case. However, the IRS did provide some insight into how it will make that determination. The final regulations provide the following examples in the field of health:
Example 1: A pharmacist who contracts on an as-needed basis with a medical facility to review and fill physician orders, make recommendations on dosing, perform inoculations, and check for drug interactions for patients receiving care at the facility
Final regulations say… This pharmacist is engaged in the performance of services in the field of health.
Example 2: A senior living facility that offers standard domestic services (housing management and maintenance, meals, laundry, entertainment, and similar services). The facility contracts with local healthcare organizations to offer residents a range of medical and health services, such as skilled nursing care, physical therapy, medical supplies, and ambulance transportation. Residents are billed for health and medical services directly by the healthcare providers rather than the facility.
Final regulations say… The facility does not perform services in the field of health. However, it’s important to note that many senior living facilities do not bill in this manner and would fall under the SSTB definition.
Example 3: Operator of a chain of surgical centers that provide outpatient medical procedures. The surgical centers enter into agreements with professional medical organizations or with medical professionals to perform procedures and provide medical care. Patients are billed by the healthcare professional or the affiliated organization for the costs of the procedure.
Final regulations say… Surgical center operator does not perform services in the field of health. Again, many surgery centers do not bill in this manner. Considerations need to be made if the surgery center has common ownership with a clinic whose doctors perform the surgical services. This would fall into the common control and services provided test and default to an SSTB treatment.
One bit of good news is where there is common ownership between an SSTB and another entity and services performed for the SSTB, only the portion of income earned from providing services to the SSTB will receive SSTB treatment. Any income earned that was not provided to the SSTB will not default to SSTB treatment. It can be carved out.
This treatment would also apply to rentals to a commonly owned SSTB. Only the portion of rental income to the commonly owned SSTB would be treated as SSTB income. However, any rental income to an unrelated third party could be carved out and would not be treated as SSTB income. Also, healthcare professionals that own their own building – or other real estate – could benefit from a proposed safe harbor for rental real estate enterprises.
Changes in Calculating QBI
If you are one of those individuals who is outside the definition of an SSTB, or own an SSTB and your taxable income falls in the SSTB phase-out range (between $315,000 and $415,000 for joint returns in 2018), then you will want to look closely at clarifications in the final regulations regarding qualified business income (QBI).
One change that can benefit taxpayers who are engaged in multiple related entities, one of which qualifies for the 20% deduction, is the ability for a pass-through entity to aggregate separate business lines when computing the QBI deduction. Under the previous rules, aggregation could only be done at the individual level. Aggregation at the entity level is expected to decrease the burdensome reporting of multiple business lines.
Taxpayers who don’t aggregate in the first year can elect to aggregate in future years; but once chosen, the election is permanent until there is a significant change in circumstances. In general, the IRS will not allow an initial aggregation on an amended return. However, the IRS has provided transitional relief by allowing taxpayers to make initial aggregations on 2018 amended returns.
The final regulations have given taxpayers a lot to think about. Determining to elect treatment under the proposed regulations released last year versus final regulations can be particularly complicated. But your HORNE tax team is here to help. There is opportunity to benefit, but we should talk through your specific situation, as the rules are complex.
We will continue watching for additional IRS clarifications relevant to the 20% pass-through deduction under Section 199A. Please consult with your HORNE LLP tax adviser on how these final regulations will affect you.