Rules for determining multiple trades or business now paramount
Speaking in her individual capacity at a recent meeting, a Treasury official announced — to the surprise of some — that a single trade or business that receives material amounts of income from an activity that is prohibited by the statute from enjoying the 20 percent deduction (such as providing eye-exams or investment management services) — and that also receives the bulk of its income from statutorily permitted activities (such as selling eye-glasses or receiving fees for managing real estate) would be entirely barred from using the new 20 percent pass-through business deduction.
The prohibited activities are referred to as being from an “SSTB” which is shorthand for Specified Service Trade or Business. The prohibited income is allowed only if it qualifies as de minimis — generally less than 5 percent of total revenue or 10 percent if gross revenues of the combine activities were less than $25 million.
If this view is confirmed in the final regulations, it will make it very important for a taxpayer owning interests in SSTB and non-SSTB activities to be able to demonstrate that they are conducted in distinct businesses. Unfortunately, the rules applicable to such a determination are far from clear. Even activities conducted in separate entities may sometimes be considered part of a single trade or business, and activities conducted in a single entity may sometimes be considered part of distinct businesses. In addition, even if the existence of two separate entities were viewed as proof that the businesses conducted by the two entities were separate, it could be costly for many taxpayers to restructure their activities in this manner.
Recent comments filed on the regulations by the Real Estate Roundtable, among others, highlighted this issue — which might arise, for example, if a single entity received permissible real estate rents and permissible real estate management fees along with a larger than de minimis amount of impermissible investment management fees. Even a small amount of revenue from impermissible activities — say, 11 percent of revenues — could disqualify the entire entity. Instead of requiring potentially costly and disruptive restructuring, or leaving the issue subject to uncertainty, the Roundtable recommended an alternative safe-harbor:
As long as the books and records of the entity readily indicate the separately determinable net income of each activity (including any necessary allocations of shared items with any necessary supporting documentation), and indicate the taxpayer’s intention to treat them as distinct businesses for purposes of section 199A, that should be sufficient to ensure that the QBI of the non-SSTB business qualifies for section 199A but the income of the SSTB business does not so qualify.
Such an outcome may be implied to be already within the contemplation of the IRS by an example in the regulations where a dermatology business and a cosmetics sale business with shared expenses, operated out of the same entity with the same, sole owner, were treated as distinct businesses. The example, however, failed to explain exactly why it reached that conclusion.
This issue is certain to be raised by many industry representatives and practitioners in discussions with government tax experts, and in the formal hearing on the regulations scheduled for Oct. 16, 2018.