By Alex Masciantonio, CPA

The 20% qualified business income (QBI) deduction is a significant tax benefit to many owners of pass-through entities. However, high-income owners of specified service trades or businesses (SSTBs) are not eligible for the 20% QBI deduction. Those SSTBs include the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading, dealing, and trades or businesses in which the principal asset is the reputation or skill of one or more owners or employees.

Taxpayers with 2019 taxable income in excess of $210,700 if single or $421,400 if married filing jointly are not eligible for the QBI deduction on income derived from SSTBs. But it’s not so simple. Many businesses perform both SSTB and non-SSTB activities, such as an entity that sells medical products and provides physician services. IRC Section 199A contains a relief provision for those businesses that derive income from SSTB and non-SSTB sources to exclude the entire trade or business from the SSTB classification if a de minimis amount of gross receipts is derived from SSTB sources.

The regulations provide that a trade or business with $25 million or less in gross receipts for the tax year would not be considered an SSTB if less than 10% of the gross receipts are attributable to SSTB activities. Those with more than $25 million in gross receipts will not be considered an SSTB if less than 5% of the gross receipts are related to SSTB activities.

The following examples illustrate application of the de minimis SSTB rule.

Example 1: ABC Company is an S corporation that sells computer products and provides information technology consulting services. For the 2019 tax year, ABC’s computer products sales were $6 million and its consulting service revenue was $2 million. ABC maintains one set of books and records for both divisions and otherwise treats the two divisions as one business. In this case, all of ABC’s income is considered SSTB income for QBI deduction purposes because more than 10% of the gross receipts are derived from an SSTB source.

Example 2: Assume the same information as in Example 1, except that ABC’s consulting service revenue was $10,000 for the tax year. In this situation, none of ABC’s income is considered SSTB income for QBI deduction purposes because less than 10% of the gross receipts are derived from an SSTB source.

Example 3: Again, assume the same information as Example 1, except that ABC maintains separate books and records for the computer products sales and consulting services divisions, the divisions have separate employees, and the two divisions qualify as separate trades or businesses. In this case, the income derived from the computer products sales trade or business is considered non-SSTB income, and what is derived from the consulting trade is treated as SSTB income.

For a part of the business to be considered a separate trade or business certain facts and circumstances must apply and Section 162 and Section 199A trade or business requirements must be satisfied. One requirement is that a complete and separable set of books and records must be maintained for each trade or business. A Section 162 trade or business must be performed with continuity and regularity, and the taxpayer must primarily have a profit or income motive.

Whether or not a trade or business is considered an SSTB for QBI deduction purposes can have a significant impact on a high-income pass-through entity owner’s tax liability. Tax practitioners and taxpayers should carefully consider whether different divisions of a pass-through entity should be treated as separate trades or businesses and whether the de minimis SSTB rule applies.

Alex K. Masciantonio, CPA, is a senior tax manager with Gunnip & Company LLP in Wilmington, Del. He can be reached at amasciantonio@gunnip.com.

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