The Tax Cut and Jobs Act of 2017 provides a 20 percent deduction to non-corporate taxpayers of up to 20 percent of the their qualified business income (QBI) from each of the their qualified trades or businesses. Aside from thresholds and phase outs, there are two conditions a taxpayer must meet. First, the taxpayer must be a “non-corporate taxpayer,” which in simple terms means C-corporations are not eligible. On the other hand, pass-through entities such as S-corporations, partnerships, and LLCs taxed as partnerships, S-corporations, or as disregarded entities, are eligible for the deduction. Second, the business income must be from a taxpayer’s qualified trade or business, which means a non-service business. Under this definition, traditional service businesses such as medical practices, law firms, and veterinary practices, would not qualify because these are service businesses although these businesses may have ancillary business income that would qualify.
Examples of ancillary businesses that could be considered a “qualified trade or business” under the Act and Proposed Regulations include medical equipment leasing, facility leasing, and practice management and medical billing services for medical practices, trustee services, litigation support services, including private investigative services, hired for law firms, and sales of pet products by a veterinarian. There are many other possibilities depending on the particular nature of the ancillary business the service business performs.
This presents these businesses, as well as other service businesses that derive income from ancillary non-service business, a tremendous opportunity to separate their service business (which is ineligible) from their ancillary business (which is eligible). In addition to creating a more tax efficient business structure, this also segregates different assets of the business from each other for liability protection purposes and, in the case of closely held entities, for estate planning purposes as well. In many cases a tax neutral reorganization under IRC § 368 may be possible, which is particularly appealing to medical providers because it potentially allows them to keep the same EIN and provider number.
As with any tax issue, the devil is often in the details. The deduction is limited to the lesser of: (1) 20 percent of the QBI; or (2) the greater of (A) 50 percent of the W–2 wages with respect to the qualified trade or business, or (B) the sum of 25 percent of the W–2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property. Because this is an either/or analysis, through careful compensation and distribution planning, a business owner can maximize the available deduction up to the statutory limit. Because each business and business owner is unique, you should consult your tax advisor to determine your eligibility for this deduction and, if deemed eligible, how to maximize this deduction. Hagan Barrett, PLLC provides a wide range of tax and planning services to our clients and we would be honored to assist you.