Qualified Business Income Deduction Alert
When the Tax Cuts and Jobs Act (“TCJA”) first came out, many professionals who were not eligible to make use of the new 20% deduction for flow-through income, known as Qualified Business Income (“QBI”), tried to find ways to separate the parts of their businesses that were eligible for the QBI deduction from the parts that were not.
The IRS lists a number of specified service trade or businesses (“SSTBs”) that do not qualify for the QBI deduction. Consultants, doctors, lawyers, and financial services providers are among the list, along with a catch all for any trade or business where the principal asset is the reputation or skill of one of its employees.
By creating additional companies, in an attempt to crack their practices into separate parts, some of which would perform the functions of the businesses that were eligible for the deduction, professionals such as doctors and financial advisors hoped to take advantage of a potential loophole to get the benefit of the 20% QBI deduction. By paying fees from a non-eligible business (i.e., medical practice, etc.) to a property rental or administrative management company that one owned, one could increase the income to QBI-eligible businesses, the income from which would receive a 20% deduction, while decreasing income to the non-QBI-eligible business, the income from which is taxed in full.
The IRS closed this potential loophole in proposed regulations addressing this particular strategy, which it believes is inconsistent with the purpose of the statute that provides the QBI deduction. The restriction implemented by the IRS applies where at least half of the ownership in the separately created business is the same as that of the SSTB. For example, if a doctor owns a building by way of a single-asset LLC and rents half the building to his own medical practice and the other half to non-related businesses, the renting of half of the building to his medical practice will itself be treated as an SSTB, not eligible for the QBI deduction.
Any restructuring that was done previously to effectuate a deduction should be accounted for accordingly. Be wary of taking the QBI deduction on pieces of your business that were once part of a whole.