Application of Sec. 199A deduction to health care

By Eric Mauner, CPA, Melville, N.Y.

Editor: Kevin D. Anderson, CPA, J.D.

On Dec. 22, 2017, President Donald Trump signed the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. The TCJA brings significant tax law changes, including a reduction of the corporate income tax rate to 21%. While the TCJA repealed the domestic production activities deduction under Sec. 199, it created a new deduction under Sec. 199A. In addition to extending an effective income tax rate reduction to owners of passthrough entities, the new deduction was intended by the legislators as an incentive to U.S. businesses to increase domestic employment or stimulate the economy through investments in capital expenditures. This objective was accomplished through a complex matrix of limitations based on W-2 wages or the tax basis of qualified depreciable property.

To encourage businesses to maintain or increase employment levels, certain types of businesses were excluded from the deduction based on their industry of operations. While businesses involving the performance of services in the health care field were generally understood as not qualifying for the Sec. 199A deduction, a closer look at the available guidance may suggest that further analysis of the facts and circumstances of a client's particular business could provide a favorable result.

Sec. 199A: Qualified business income

In general, Sec. 199A provides for a deduction in any tax year of an amount equal to the sum of (1) the lesser of (A) the combined qualified business income of the taxpayer, or (B) an amount equal to 20% of the excess of (i) the taxable income of the taxpayer for the tax year, over (ii) the sum of any net capital gain, plus the aggregate amount of the qualified cooperative dividends, of the taxpayer for the tax year, plus (2) the lesser of (A) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (B) taxable income (reduced by net capital gain) of the taxpayer for the tax year.

The amount determined to be deductible for each trade or business is the lesser of (1) 20% of the taxpayer's qualified business income from the qualified trade or business, or (2) the greater of (A) 50% of the W-2 wages attributable to the qualified trade or business, or (B) the sum of 25% of the W-2 wages attributable to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

Qualified trade or business for purposes of Sec. 199A

Sec. 199A(d)(1) defines the term "qualified trade or business" as any trade or business other than a specified service trade or business, or the trade or business of performing services as an employee. Under Sec. 199A(d)(2), a "specified service trade or business" is defined as any trade or business that is described in Sec. 1202(e)(3)(A) (with certain modifications) or that involves the performance of services that consist of investing and investment management, or trading or dealing in securities, partnership interests, or commodities.

Why refer to Sec. 1202?

Sec. 1202, enacted in 1993, provides for an exclusion (subject to certain limitations) of gain on the sale of qualified small business (QSB) stock. The benefit was intended to stimulate domestic employment by startup businesses, including those funded by private equity. Similar to Sec. 199A, Sec. 1202 provides a limitation based on the industry of the trade or business to focus on businesses that employ workers other than owner-employees.

Sec. 1202(e)(3)(A) identifies activities that will not qualify for QSB treatment as those involving the performance of services in the fields of engineering, architecture, health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business the principal asset of which is the reputation or skill of one or more of its employees. Sec. 199A(d)(2)(A) modifies paragraph (e)(3)(A) in Sec. 1202 by removing the reference to engineering and architecture and adding owners to the "reputation or skill" test.

While Sec. 199A is new to the Code, Sec. 1202 is not. As practitioners await Treasury's issuance of regulations under Sec. 199A, it may prove useful to look to the available guidance on Sec. 1202.

While Secs. 1202(e) and 199A do not provide a definition of "services performed in the field of health," under Temp. Regs. Sec. 1.448-1T(e)(4)(ii), they are described as the provision of medical services by physicians, nurses, dentists, and other similar health care professionals. The performance of services in the field of health does not include the provision of services not directly related to a medical field, even if the services relate to the health of the service recipient. The regulations identify the operation of health clubs or health spas that provide physical exercise or fitness conditioning to their customers as examples of the performance of services not considered to be in the field of health.

Despite the absence of any reference to the regulations under Sec. 448, the IRS has adopted this definition in connection with rulings related to questions of Sec. 1202, as showcased in two letter rulings discussed below. While a letter ruling may not be relied upon as precedent by any taxpayer other than the specific taxpayer to whom it was issued, it provides guidance as to the IRS's position on a particular matter.

Letter Ruling 201717010

On the limited facts of the ruling, the taxpayer(s) seeking the letter ruling owned stock of a corporation that developed a tool to provide more complete and timely information to health care providers. Specifically, the corporation used proprietary technologies for the precise detection of something identified in the ruling letter only as "B." The corporation analyzes test results and then prepares laboratory reports for health care providers.

The corporation's clients were doctors and other health care providers that it provided with a laboratory report including a summary of the test results but without discussing diagnosis or treatment. The corporation neither discussed with, nor was informed by, health care providers regarding the diagnosis or treatment of a health care provider's patients. The corporation's sole function was to provide health care providers with a copy of its laboratory report. The corporation neither took orders from nor explained laboratory tests to patients, and its only direct contact with patients was billing patients whose insurer did not pay all of the costs of a laboratory test.

In addition, the corporation represented that the preexisting skills its employees brought with them to the corporation were not useful in performing the tests for the corporation and that skills the employees develop at the corporation were not useful to other employers.

Further, none of the corporation's revenue is earned in connection with patients' medical care. Other than the laboratory director, the corporation's laboratory technicians are not subject to state licensing requirements or classified as health care professionals by any applicable state or federal law or regulatory authority. Although the corporation's laboratory reports provide valuable information to health care providers, the corporation does not provide them with diagnosis or treatment recommendations for treating their patients, nor is it aware of the health care providers' diagnosis or treatment of the health care providers' patients.

Based on the facts and information submitted, the IRS ruled that for purposes of Sec. 1202(e)(3), the corporation was not in a trade or business (1) involving the performance of services in the field of health or (2) where the principal asset of the trade or business is the reputation or skill of one or more of its employees.

Letter Ruling 201436001

The taxpayers seeking the ruling letter own stock in a company that provides products and services primarily in connection with the pharmaceutical industry. In particular, the company works with clients to help commercialize experimental drugs. Its business activities include research, development, manufacturing, and commercialization. More specifically, its activities under these broad headings include (1) research on drug formulation effectiveness; (2) precommercial testing procedures such as clinical testing; and (3) manufacturing drugs. In addition, the company works with clients to resolve certain issues faced by the pharmaceutical industry, such as developing successful drug manufacturing processes. To perform these tasks, the company uses its physical assets, such as its manufacturing and clinical facilities, as well as its intellectual property assets, including its patent portfolio. The company's successful performance of these activities in the past has earned it several valuable relationships in the pharmaceutical industry.

Based on the facts submitted, the IRS ruled that the company qualifies for the exclusion of Sec. 1202 notwithstanding the proximity of its business activities to the field of health. The IRS came to this conclusion because the company was not in the business of offering service in the form of individual expertise. Instead, its activities involve the deployment of specific manufacturing assets and intellectual property assets to create value for customers, and, essentially, it was a pharmaceutical industry analogue of a parts manufacturer in the automobile industry.

Guidance needed

It seems reasonable to conclude that if the companies referred to in the above rulings were passthrough entities, the owners could be entitled to a Sec. 199A deduction despite the conduct of a service trade or business operating in concert with health care providers.

In the absence of guidance in the form of Treasury regulations under Sec. 199A, other areas of the Code and/or regulations may provide preliminary guidance as to the activities that constitute health care services. Considering the cost of pursuing definitive guidance by requesting a letter ruling, tax professionals and their clients alike hope that detailed authoritative guidance on applying Sec. 199A will be issued in time for the 2019 filing season.


Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Washington.

For additional information about these items, contact Mr. Anderson at 202-644-5413 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

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