199A Proposed Regulations Address the ”Crack-and-Pack” Strategy
Since the enactment of Section 199A as part of the Tax Cut and Jobs Act late last year, tax practitioners have been devising ways to take a specified service trade or business, such as a physician group, and segregate the parts of the business that are a specified service trade or business from the parts that are not. For example, there has been speculation as to whether an S co rporation operating a physician group that provides medical services (which is a specified service trade or business), owns its building, and employs administrative and billing staff could be divided into three S corporations. S corporation 1 would provide medical services to patients, S corporation 2 would own the medical office building and lease it to S corporation 1, and S corporation 3 would employ the administrative and billing staff and provide its services to S corporation 1 in exchange for fees. The hope would be that the common owners of the three S corporations would be eligible for a 199A deduction with respect to S corporation 2 and S corporation 3 (they would generally not be eligible for a 199A deduction if all of the components of the physician group were contained within one entity).
The proposed 199A regulations provide rules addressing this issue in Section 1.199A-5(c)(2). These rules provide that a specified service trade or business includes any trade or business that provides 80% or more of its property or services to a specified service trade or business if there is 50% or more common ownership (using the related party rules in Sections 267(b) and 707(b)) of the two trades or businesses. If a trade or business provides less than 80% of its property or services to a specified service trade or business that has 50% or more common ownership, then the portion of the trade or business providing property or services to the commonly-controlled business will be treated as part of the specified service trade or business. For example, if a dentist owns a dental practice and a building used in the practice in separate entities, and 40% of the real estate is leased to the dental practice and 60% of the real estate is leased to an unrelated tenant, then 40% of the real estate business will be treated as part of the dental specified service trade or business. But, if 80% of the real estate was leased to the dental practice, then all of the real estate would be treated as part of the dental specified service trade or business.