By Jim Chinn, Tax Manager | Healthcare and Medical Services Team
The 20 percent “pass-through” deduction on Qualified Business Income (QBI) may have been the most talked about change implemented by the Tax Cuts and Jobs Act (TCJA) in late 2017. At first glance the language of the TCJA appears to single out many service business owners, including medical practices, by prohibiting them taking the deduction; however, there are certain situations where medical practice owners can benefit from this deduction.
Qualified Business Income Deduction Overview
Before we dig in, it will helpful for you to have a basic understanding of how the QBI deduction is calculated. In general, QBI is income earned within a pass-through entity in the United States. A pass-through entity is essentially a non-corporate entity and would include sole proprietorships, partnerships, and S-Corporations. The deduction is calculated as the lesser of 20% of (i) qualifying income from the pass-through entity or (ii) 20 percent of taxable income as reduced by net capital gains. At certain income levels ($321,400 for married filing jointly and $160,725 for single taxpayers in 2019) the deduction is further limited by the amount of wages and qualifying property within the pass-through entity. The deduction is available for tax years ending on or before December 31, 2025. The rules outlined above are very simplified – please see our article on the 199A Pass-Through Deduction for a more complete understanding of how it is calculated.
As I alluded to earlier, the code excludes income earned from Specified Service Trades or Businesses (SSTB) from QBI. The code defines SSTBs as businesses in the fields of health, law, accounting, and several other named industries. One important exception to this rule is that if the owner of an SSTB has taxable income below $421,400 (married filing jointly, half that for single filers) in 2019, then some of the SSTB income may qualify for the deduction. If taxable income is below $321,400 (married filing jointly, half that for single filers) in 2019, then all of the income earned in an SSTB would count towards the 20 percent QBI deduction.
And herein lies the takeaway – managing taxable income is more important than ever. Literally $1 of income can cause you to miss out on the deduction entirely!
“Tried and True” Strategies for Managing Taxable Income
- Maximize your business retirement plan contributions
- Maximizing bonus depreciation and/or section 179 deductions on new asset purchases
- Maximizing eligible HSA contributions
- Deferring income and accelerating expenses to the extent possible
- Managing capital gain income by harvesting capital losses or deferring capital gains by making a Qualified Opportunity Zone Investment (more on that here)
- “Bunching” charitable contributions in specific years – this is one of the newer strategies so additional explanation is warranted. Since the TCJA doubled the standard deduction and capped state and local tax deductions to $10,000, many taxpayers will find themselves taking the standard deduction going forward. When you take the standard deduction you lose the tax benefit of charitable contributions. If, for illustration purposes, you made two years’ worth of charitable contributions in one year you may be able to push your itemized deductions above the standard deduction amount. This would allow you to receive more tax benefits when compared to making the same amount of contributions over a two year period.
Owning Real Estate Used by a Medical Practice
A creative taxpayer may think that owning real estate used by the medical practice could be a way to shift otherwise non-qualified income to QBI. Since income from real estate activities could be eligible for the QBI deduction, couldn’t you increase rents that the medical practice pays to the real estate entity to maximize your deduction? Unfortunately, the IRS thought of this strategy when drafting the regulations and closed this potential loophole by treating the income earned any entity that provides property or services to an SSTB as SSTB income if there is common ownership between the two entities.
Defining the Field of Health
As mentioned above, SSTBs include businesses in the field of health – but what does it mean to be “in the field of health”? According to the regulations the field of health includes “the provision of medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and similar healthcare professionals performing in their capacity.” Services in the field of health do not include services “not directly related to the medical services field” for example the operation of health clubs or spas, payment processing, or the research, testing, manufacturing and/or sales of pharmaceuticals. The regulations currently do not define “medical services field” which can cast a shadow of uncertainty on some fields. Are cosmetic or similar procedures that are not covered by most insurance plans part of the “medical services field”? There may be an argument that those types of procedures would not be considered “medical services” and may fall outside of the “field of health” designation. If your practice performs these services that fall outside of the field of health alongside standard medical procedures it may be advisable to setup a separate entity to provide these services.
When the statutory language of the QBI deduction was first released it may have seemed that medical professionals got the “short end of the stick;” however, with careful planning and consideration they may be able to benefit from the deduction after all.
Questions on QBI deduction eligibility for your medical practice? Contact our Healthcare and Medical Practices Team. We are here to help.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.