As a business owner, many of your important financial decisions don't directly involve revenue. Sometimes, it's about making the right choices when it comes to tax deductions.
One such example is the qualified business income deduction, a new benefit for many U.S. small business owners. But if you operate a specified service trade or business (SSTB), you can only claim the QBI in some circumstances. Here's what you need to know in order to keep your business bottom line as healthy as possible.
What Qualifies as an SSTB?
The Internal Revenue Service (IRS) has a rather precise definition of SSTB. It includes "any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners." The agency goes on to specify those providing services in health, law, performing arts, accounting, actuarial science, and consulting, among many others, as operating an SSTB.
This is not an exhaustive list of specified service trade or businesses. Indeed, the IRS issued further statements to clarify that the "reputation or skill" phrase refers primarily to celebrity income. But that is not the only wording that may make it difficult to determine what is a specified service trade or business. The IRS excluded some professions from the SSTB definition, like architecture, engineering, and some financial services occupations.
Even consultants, although they are specifically mentioned in the IRS' specified service trade or business list, do not always fall under the definition. For example, consultants may be those who provide professional advice, but the IRS excludes salespeople who give training courses on a product. Additionally, doctors fall under the "health" definition, but fitness instructors and others who improve wellness -- in other words, improve health -- do not.
In addition, some businesses may be a combination of SSTB and non-SSTB. In that case, the de minimus rule may apply. If your total receipts are more than $25 million, and 5% of those receipts are from an SSTB, the entire entity is subject to the SSTB rules. If your total receipts are less than $25 million, and 10 percent is from SSTB, then the entire thing is considered SSTB by the IRS.
Because whether or not you are a SSTB is so important, it's best to talk to a tax expert. That way, if you fall into a grey area, this professional can best advise you on which deductions may apply.
What Does This Mean for the QBI Deduction?
So why is it important to know if you operate a specified service trade or business? Under recent tax legislation, some business owners can claim 20% of their qualified business income in certain pass-through entities. Those entities include sole proprietorships, partnerships, limited liability companies (LLCs), S corporations, and some trusts and estates. The definition of income is restricted to only those items included in taxable income. It does not include such things as capital gains, interest income, and some dividends.
But the QBI is subject to certain restrictions. First, there's a threshold income amount. For 2019 tax returns, that threshold amount is $160,700 for a single taxpayer and $321,400 for married taxpayer filing jointly. If your income falls below this amount, it doesn't matter whether you operate an SSTB. You can take the 20% deduction. But it becomes trickier the more money your business makes.
If you are above the threshold, but below $210,700 ($421,400 if married, filing jointly), you may get some of the deduction -- even if you operate an SSTB. But once you reach this threshold of $210,700/$421,400, you cannot claim the deduction at all as an SSTB. If you do not operate an SSTB, your deduction under the QBI is typically limited to a percentage of your employee's wages, as represented by their W-2s.
The difference is pretty clear. Here are a couple of specified service trade or business examples:
- An M.D. in private practice with QBI of $500,000 cannot claim the deduction; an M.D. with QBI of less than $160,700 in 2019 can claim 20%.
- An elite fitness coach with QBI of $500,000 can likely claim the deduction as a percentage of W-2 employees; a fitness coach with QBI of $160,700 in 2019 can claim 20%.
This adds up to quite a bit of money for business owners, regardless of wealth or stature. That's why it's a good idea to consult with a tax expert who knows the Tax Code thoroughly.
Key Business Decisions of SSTB Owners
SSTB may be a tax definition. But it captures a large number of entrepreneurs who operate a specific type of business.
Often, the success of these businesses comes down to the quality and volume of services provided by the owner. That means a lot of risk lies with the people at the top. That's the case whether the SSTB pass-through entity is a sole proprietorship, partnership, LLC, or S-corp. Consider the following tips to keep your business running smoothly:
- Hire a qualified accountant to find you small business tax deductions. This is particularly important since SSTB status excludes you from claiming the QBI once you reach the threshold income amount.
- Research and buy the right business insurance. In particular, if you run a personal services business, you may be personally responsible if something goes wrong. That can include anything from unhappy clients who want to sue under the contract, to clients who have been injured or suffered losses as the result of their interaction with the company.
- Consult with business managers about mixed service enterprises. As discussed, you can lose the QBI deduction even if only a small percentage of your receipts come from SSTB. Work with someone who can help you find the right balance that allows you to grow and expand while limiting your tax burden.
At the end of the day, your business decisions depend on many factors. Keep tabs on your growing revenue, and maintain positive relationships with tax and accounting professionals who can provide valuable advice. Then you'll have a good experience with IRS come tax time, no matter where your income level lies.