Section 199A and The Many Still Unanswered Questions for Physicians and Other Service Providers
September 5, 2019
I recently returned from a conference where a group of my CPA peers had an interesting and spirited debate over whether the Qualified Business Income (QBI) deduction was available to Ambulatory Surgery Centers (ASCs), Management Service Organizations (MSOs) or hospitals. Along with 50 CPAs that specialize in healthcare and other service organizations, there were two tax attorneys participating in the discussion. Much of the debate had to do with defining what constitutes “performance of services in the field of health” and what does not.
At issue is the 20% of net income Qualified Business Income (QBI) deduction for the investors in the entity. At risk is the potential of audit and litigation, as a “test case” for whether a particular entity’s fact set qualifies for the QBI deduction. If the decision to deduct QBI for 2018 is made now, an audit may not be initiated until 2021 and a trip to U.S. Tax Court might not take place until 2023.
While there are public and private versions of all of the above entities, the reporting from companies that already filed returns and issued K-1s of whether the QBI deduction applies appears to vary based upon whether the entity is institutional (public) or entrepreneurial (private). The public companies appear to be taking the more conservative approach that the QBI deduction does not apply, while many (but not all) private entities have adopted the more aggressive stance that they qualify for the deduction.
There are several issues driving this argument including the di minimis rule for provision of medical care stating that if less than 10% of revenue is incurred in the provision of healthcare, it is not considered a Specified Service Trade or Business (SSTB). The regulations to IRC Section 199A also include numerous examples of the difference in business circumstances:
- A pharmacist is considered a Specified Service Trade or Business (SSTB), but the sale of prescription drugs and medical devices by a retail pharmacy does not, by itself, constitute a trade of business performing services in the field of health by the pharmacy.
- A surgical center that does not employ physicians, nurses and medical assistants, but rather enters into agreements with other professional medical organizations or directly with medical professionals that perform the procedures, provide all medical care and bill the patients directly for the cost of the procedure conducted by their medical team, does not perform services in the field of health.
The complexity of determining whether or not an entity’s facts actually qualify for the QBI deduction is another issue. Owners may believe their entity’s actual fact set fits into the IRS-provided examples, but a closer analysis may determine it’s far from the case. State regulations or other contractual requirements can create material departures from the examples. For instance, some states require in-house supervision of all healthcare staff. Threading the “not providing healthcare services” needle is a difficult task, and if performed by an MSO, that entity per se is an SSTB and does not qualify for the deduction. A small amount of revenue from healthcare services (10% for a center generating under $25 million in revenue and 5% if revenue is over $25 million) can taint the entire business.
Test cases in U.S. Tax Court typically take several years and often cost six to seven figures in legal and accounting fees to adjudicate. If the entity loses, on top of the fees associated with pursuing the case, it faces amended returns at higher tax rates, interest, and several layers of penalties (late payment, substantial underpayment (20%) and/or civil fraud (75%) of unpaid liability to name a few) that add up over the years.
Per a July 26th article in Accounting Today*, the author cites 47 clarifications released to date by the IRS on section 199A. Yet the IRS has left plenty of room for interpretation not only in the healthcare arena, but with many independent contractors that deal in internet-based enterprises of all types in many different industries.
Unfortunately, the section 199A murkiness highlights the change in the IRS from a neutral tax administration agency to a predatory apparition that lays invisible snares for the unwary taxpayer and sets the stage for many legal challenges down the road. The lack of clarity provided in IRS regulations is both insidious and disturbing.
This lack of clarity places CPAs in an unenviable position: Do we protect the client’s interests by not taking the deduction and limiting exposure to the ugly deferred consequences of a bad audit? CPAs face client backlash and get fired often for not taking advantage of every tax break available. Alternately, does the CPA take the deduction today to gain the tax benefit for the client, only to face the malpractice litigation five years down the road when a bad audit result has taken place and the client claims the CPA should have known? Communication between client and CPA at this juncture is paramount regarding the risk vs. reward where a clear writing of the law is not available.
A square peg can be hammered into a round hole to make it fit. Getting that peg out of the hole is another issue. Common sense and risk avoidance should be key in making the 199A QBI deduction decision today. If you clearly fit within the parameters of 199A, by all means, take the deduction. If not, don’t let the riverboat gambler in you take that risk. An aggressive decision made now could have significant negative results down the road. This was the consensus of the CPAs and tax attorneys in the room following our very long debate. Since we aren’t allowed input into the interpretation of the law, better to pass on a deduction than participate in malpractice litigation.
*AccountingToday, July 26, 2019, Shaun Hunley, The element of tax reform that still haunts accountants.
About the Author:
Tom is one of the founding partners of Reimer, McGuinness & Associates, P.C. He earned his accounting degree at the University of Houston and has been a licensed CPA since 1983 and has been working in public accounting for 37 years. While Tom works with many different industry groups and types of businesses, throughout much of his career he has worked in the area of physician side healthcare, working with physicians and physician groups in many ways. From helping with their tax and accounting issues to providing assistance in the management of their offices, reviewing reimbursement, providing valuations of medical practices, and many other consultative areas.