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By Lydia O’Neal
Private equity and hedge funds, lobbyists, and investment bankers are among those shut out of the 2017 tax act’s 20 percent deduction, above certain income thresholds, under new IRS proposed regulations.
Veterinarians and skilled nursing facilities were also denied the write-off for pass-through businesses—for which income is taxed at the individual owner level—above incomes of $207,500 for single filers and $415,000 for joint filers. Beyond those thresholds, “specified service” businesses are excluded.
Up to those amounts, and starting at incomes of $157,500 for single filers and $315,000 for married filers, a restriction based on wages and capital kicks in, phasing out the 20 percent deduction, created under new tax code Section 199A.
But pass-through service workers in plenty of trades—banks, spas, and insurance, for example—came out on top. If the proposed regulations (REG-107892-18) released Aug. 8 remain in their current form, top earners in those businesses can effectively reduce their rates by about 7 percent.
“I think they went as far as they could within the statute to be as broad as possible,” said Don Susswein, a principal at RSM US LLP in Washington. “That makes sense, given the legislative intent.”
Here are 10 winners and losers under the proposed regulations.
Along with consulting, law, health, and “financial services,” the term “specified service” includes a business performing “services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities,” as defined by Section 475.
The Internal Revenue Service threw investment bankers, financial advisers, and wealth planners into the “financial services” bucket. The agency defined “investing and investment management” to include any business “that earns fees for investment, asset management services, or investment services”—in other words, generally, managers of private equity and hedge funds, tax professionals said.
LPL Financial LLC, a financial advisory firm in San Diego, which asked the IRS and Treasury Department to leave investment advisers out of the “specified service” definition, said in an Aug. 9 statement to Bloomberg Tax that it was “disappointed” with the proposed regulations, but “will continue our work with the administration and Congress” on the issue.
A bank structured as a pass-through—such as a limited liability company, S corporation, or partnership—“is not included as part of financial services,” the proposed rules said.
The tax code subsection listing “specified services,” 1202(e)(3)(A), is followed by another subsection, 1202(e)(3)(B), that does include “banking,” but lawmakers only referenced the former when crafting the new 20 percent deduction.
Lobbying groups such as the American Bankers Association, Independent Community Bankers of America, the Subchapter S Bank Association, and the Mortgage Bankers Association made this argument in letters to IRS and Treasury officials. The government, the proposed rules indicated, heard them loud and clear.
“The Treasury Department and the IRS agree with such commenters that this suggests that financial services should be more narrowly interpreted here,” the regulations said.
“Consulting” is one of the “specified service” pass-through businesses whose owners can’t take the deduction, and according to the proposed rules, that term includes lobbying.
Although they may not be able to write off 20 percent of their taxable income, lobbyists should get plenty of business out of the new guidance, as practitioners told Bloomberg Tax the proposed regulations would spur a fresh wave of comment letters and lobbying.
The regulations likely pleased insurance companies that asked the IRS and Treasury to leave their industry out of the “specified service” category.
While the IRS said the list of investment and brokerage services includes asset managers, the rules say that list doesn’t include insurance agents and brokers.
Professional employer organizations feared a mass exodus of clients due to the limit on the deduction based on wages and capital. They can breathe a sigh of relief, practitioners told Bloomberg Tax.
In the proposed regulations for the deduction, the IRS “got the right result with W-2 wages when they’re paid by a different party,” said Michael Greenwald, a partner at Friedman LLP in New York. “If using a PEO makes sense for my business, I shouldn’t be penalized for that.”
Larry “LJ” Roberts, president of the Dallas-based PEO LL Roberts Group, wrote in an Aug. 9 note to staff that the proposed regulations mark “a huge victory for PEOs and their clients” and “a positive resolve to any concerns that CPAs or other advisors may have had regarding their clients’ eligibility for the credit as clients of PEOs.”
The list of “specified service” businesses includes those providing health services, but the American Health Care Association and the National Center for Assisted Living pressed the IRS and Treasury to leave assisted-living centers and skilled nursing businesses out of the definition.
The proposed rules said nursing services can’t get the deduction above the higher income thresholds, but was less clear when it comes to assisted-living facilities.
AHCA President and CEO Mark Parkinson said in a statement that the group was “disappointed that the proposed rule appears to prevent skilled nursing facilities from fully capitalizing on” the deduction, and that “the proposed rule does not directly address assisted living, it appears that the language would allow assisted living communities the deduction.”
The AHCA “will provide comments to this proposal and hope that reason prevails and the final rule implements what we know Congress intended,” he said.
Also under the “health” service umbrella were veterinarians, something the proposed regulations made explicit.
This designation likely disappointed groups like the American Veterinary Medical Association, which lobbied on “implementation” of the new deduction, according to a second-quarter disclosure form. The AVMA said previously that it hoped the IRS would “keep its traditional scope” of health services “out of animal spaces.”
“Health clubs or health spas that provide physical exercise or conditioning to their customers” didn’t make it into the “health” service category, the proposed regulations said.
That’s because in the IRS’s view, according to the rules, a health service “does not include the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient.”
Actuaries and “similar professionals” may be considered “specified services” under Section 199A, but the IRS carved out some exceptions to that term that could please analytics firms structured as pass-throughs—if they aren’t offering clients financial risk-related insights.
“Analysts, economists, mathematicians, and statisticians not engaged in analyzing or assessing the financial costs of risk or uncertainty of events” are outside of the definition of actuarial science, the proposed regulations said.
Another description of a “specified service” is a business in which the “principal asset” is the “reputation or skill” of at least one employee.
The IRS narrowed the scope of the “reputation or skill” standard so that it only applies when the individual: receives income for endorsing goods or services; is paid for or licenses the use of their image, name, voice, trademark, or other symbol “associated with the individual’s identity”; or is paid for making appearances on TV, social media, radio, or other “forums,” according to the proposed regulations.
The guidance confirmed that celebrities selling their names and likenesses as commodities are ineligible for the write-off.
But the IRS’s reading of the law represented a win for individuals who started their own service business, who were at risk of getting “trapped by the rule,” said Rachel L. Partain, a member of Caplin & Drysdale, Chartered in New York.
“Now,” she said, “it’s pretty tailored.”
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