Final Section 199A Regulations Confirm Controversial “Cliff” Treatment in De Minimis Aggregation Rule but There Is a Parachute
The proposed Section 199A regulations provide a de minimis rule for trades or businesses with small amounts of gross receipts attributable to a specified service trade or business (“SSTB”). Specifically, the proposed regulations provide that if a non-SSTB has some relatively small elements that are SSTB services, then the SSTB services will not taint the treatment of the overall business. Specifically, the rule provides that for a trade or business with gross receipts of $25M or less for a taxable year, the trade or business will not be treated as an SSTB if less than 10 percent of its gross receipts are attributable to an SSTB. If the gross receipts of the trade or business are more than $25M, then the 10 percent threshold is dropped to 5 percent. For example, if an eyeglass store had $10 million of total gross receipts and $9.5 million of such gross receipts were attributable to the sale of eyeglasses, and $0.5 million of the gross receipts were attributable to eye examinations performed by ophthalmologists, then the entire trade or business would be considered a non-SSTB for purposes of the Section 199A deduction.
We previously blogged that the proposed regulations did not address a scenario where, for example, $2 million of the gross receipts were attributable to eye examinations. In that scenario, we questioned whether the entire $10 million business would be treated as an SSTB, which would be a harsh result, especially for a taxpayer that is just over the de minimis threshold. A better answer, which commentators to the proposed regulations (including Williams Parker) proposed to IRS, would be that the eyeglass and eye exam activities are treated as two separate trades or business for Section 199A purposes.
The final Section 199A regulations, which were promulgated on January 18, 2019, adopt both approaches. The example in Section 1.199A-5(c)(1)(iii)(A) of the final regulations confirms that the 5/10 percent de minimis threshold acts as a “cliff,” such that once the de minimis threshold is exceeded, all the income is considered income of an SSTB. However, the example in Section 1.199A-5(c)(1)(iii)(B) of the final regulations provides a parachute if the taxpayer can establish that its non-SSTB and SSTB operations are two separate trades or businesses (with separate books and records, invoicing, and employees). In that case, the non-SSTB trade or business would be eligible for the Section 199A deduction.
This post is one in a series of posts on the 199A regulations.