TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, October 18, 2018

WSJ: What’s A Service Business? That’s Now A Multibillion-Dollar Tax Question

Wall Street Journal, What’s a Service Business? That’s Now a Multibillion-Dollar Tax Question:

For Extraco Banks of central Texas, the 2017 tax law that promised a 20% deduction is turning into something of a headache.

S-corporation banks such as Extraco technically qualify for the break. But under proposed IRS regulations, Extraco might lose out, because it gets too much revenue from managing trusts and selling mortgages into the secondary market. Those activities may be ineligible and taint the ability of the whole business to qualify.

Situations like Extraco’s were a crucial part of an IRS public hearing Tuesday, as the agency prepares to finish the rules for the new 20% deduction for pass-through businesses such as partnerships and S corporations, closely held companies that don’t pay standard corporate taxes.

Companies and the government are struggling over who is eligible for the tax break, and representatives of veterinarians, escrow agents, automobile dealers and franchised businesses pleaded their case at the hearing. Major League Baseball sent in a new detailed letter explaining why teams think they should get the tax break.

In last year’s law, Congress created the 20% deduction for pass-through businesses, which pay taxes through their owners’ individual tax returns. The break shaves their top tax rate from 37% to 29.6%. Lawmakers were trying to cut rates for millions of closely held businesses like they did for corporations.

But Congress aimed to prevent lawyers, doctors and similar professionals from turning high-taxed labor income into lower-taxed business income. It named which specified service businesses are ineligible, listing industries such as law, medicine, consulting and athletics.

In those industries, once taxable income hits $157,500 for an individual or $315,000 for a married couple, the break starts phasing out.

Congress left part of the problem for the Treasury Department and the Internal Revenue Service. How much of a specified service can a business perform before it becomes a specified-service business? Once a business crosses that level, does it lose the whole deduction?

Besides banks, insurance brokers worry that consulting services could make them lose the deduction. Pharmacists offering direct health care are on the bubble, too. Assisted living centers say they might provide too much health care to qualify.

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