It’s been almost nine months since President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) and many physicians are still scratching their heads wondering how the changes in the tax law will affect them. The reality is that the owner physician may end up paying more or equal tax compared to pre-2018 tax rules. How can that be? Let me explain.
The TCJA brings about significant law changes to the Internal Revenue Code (IRC), including individual tax rate changes, a reduction of the corporate tax rate to 21% and the introduction of a new qualified business income deduction available to pass-through entities. What is this new qualified business income deduction? The TCJA created a new deduction under Section 199A. In general, Section 199A makes available a deduction of up to 20% of the qualified business income of an eligible pass-through entity. An eligible pass-through entity can be either a sole proprietorship, partnership, S corporation, trust or estate. There are, of course, thresholds and limitations that apply. The overall purpose of adding this deduction was to encourage U.S. businesses (this deduction does not apply to foreign businesses) to increase domestic employment and to make capital expenditures.
The Section 199A deduction is simply calculated as follows, if the owner physician’s taxable income is less than $315,000 for married filing joint filers and $157,500 for all other filers; 20% of qualified business income, limited to the excess of taxable income less net capital gain. For example, Tina and Joe, married filing joint taxpayers, have qualified business income of $180,000, capital gain income of $70,000 and $45,000 of itemized deductions for 2018. Their tentative Section 199A deduction is $36,000 ($180,000 * 20%). However, their deduction is limited to 20% of taxable income less capital gains. Therefore, Tina and Joe’s Section 199A deduction is $27,000 ($135,000 * 20%).
All taxpayers are eligible for the 20% qualified business income deduction if their taxable income is less than $315,000 (MFJ) and $157,500 (all other taxpayers). The deduction is prohibited for those taxpayers that have taxable income in excess of $415,000 (MFJ) and $207,500 (all other taxpayers) if the business does not meet the definition of a qualified trade or business according to Section 199A. The deduction is proportionately limited for the phase out of $100,000 (MFJ) and $50,000 (all other taxpayers). Section 199A defines a qualified trade or business as any trade or business other than a specified trade or business or the trade or business of performing services as an employee. The code section defines a specified trade or business as any trade or business which is described in section 1202(e)(3)(A) (applied without regard to the words engineering and architecture) or which would be so described if the term “employees or owners” were substituted for “employees” therein, or which involves the performance or services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)). Why is this an important definition to owner physicians? Well, section 1202(e)(3)(A) defines a qualified trade or business as any trade or business OTHER THAN any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees. Section 1202 does not provide a further explanation of what qualifies as a performance of services in the field of health. The owner physician needs to dig a bit deeper for that definition. One can find that definition in Temporary Regulation Section 1.448-1T(e)(4)(ii). This temporary regulation indicates that the performance of services in the field of health means the provision of medical services by physicians, nurses, dentists, and other similar healthcare professionals. The performance of services in the field of health does not include the provision of services not directly related to the medical field, even though the services may purportedly relate to the health of the service recipient.
Based on the above definitions of what entities don’t qualify as qualified business income, the owner physician most likely will make the determination that their business income will not qualify for the new Section 199A 20% deduction once their taxable income surpasses $415,000 (married filing joint) and $207,500 (all other taxpayers). That being said, each owner physician’s situation may be different and therefore, should be analyzed before determining the coveted 20% deduction is ineligible.
In August of 2018 the Internal Revenue Service issued proposed regulations to Section 199A. Prior to these proposed regulations, it was thought that physician owners that also own real estate property that was rented to the physician owner would still be eligible to take the 20% deduction on their real estate entity once certain limitations were applied. Proposed §1.199A-5(c)(2) provides that a specialized service trade or business includes any trade or business with 50 percent or more common ownership (directly or indirectly) that provides 80 percent or more of its property or services to a specialized service trade or business. For example, Joe, a general practitioner, owns a physician practice and also owns the building the practice is located. Under the proposed regulations, the renting of the building to the general practitioner will be treated as a specialized service trade or business. The proposed regulations also provide that if a business provides less than 80 percent of its property or services to a specialized trade or business, only the income from that property or those services are treated as income from a specialized service trade or business. Let me point out that these are only proposed regulations and should not be relied upon until they are made final.
In conclusion, it is imperative that each physician owner fully analyze the facts and circumstances of their particular situation in order to determine if the available guidance precludes them from taking advantage of the Section 199A 20% deduction. Additionally, the physician owner should keep an eye out for any additional regulations that may be issued regarding Section 199A in general.