Determining what is a separate trade or business for Sec. 199A purposes

By Kate Abdoo, J.D., LL.M., Stamford, Conn.; Lee Gay, CPA, Washington, D.C.; and John Kerrigan, J.D., LL.M., Washington, D.C.

Editor: Annette B. Smith, CPA

The 2017 tax reform legislation, P.L. 115-197, known as the Tax Cuts and Jobs Act (TJCA), includes a new deduction for qualified business income (QBI) from sole proprietorships and relevant passthrough entities (RPEs). Sec. 199A allows individuals (and some trusts and estates) to deduct up to 20% of the combined QBI from qualifying trades or businesses, subject to certain limitations. QBI includes the net amount of qualified items of income, gain, deduction, and loss for any qualified trade or business of the taxpayer (Sec. 199A(c)(1)).

A qualified trade or business is any trade or business that is not a specified service trade or business (SSTB) or the trade or business of performing services as an employee (Sec. 199A(d)(1)). Unless an individual's taxable income is below a certain threshold (for 2019, $210,700 for an individual or a head of household, or $421,400 if filing a joint return), no income from an SSTB qualifies for the Sec. 199A deduction. SSTBs include trades or businesses that provide services in the following fields: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investment management, trading, dealing in securities, partnership interests or commodities, and a trade or business the principal asset of which is the reputation or skill of one or more of its employees (Sec. 199A(d)(2)).

Final regulations under Sec. 199A (T.D. 9847), released on Jan. 18, 2019, provide a de minimis rule allowing a trade or business to avoid SSTB status where the business provides only a small amount of SSTB services (Regs. Sec. 1.199A-5(c)(1)). However, a trade or business that falls outside the de minimis rule will be treated as an SSTB in its entirety. Individuals or RPEs engaged in businesses that include SSTB activities should determine whether the trade or business operations should be (or could be reorganized to be) treated as multiple trades or businesses, allowing individual owners potentially to benefit from the Sec. 199A deduction for non-SSTB QBI.

This item discusses the general factors courts and the IRS have considered in determining whether a taxpayer is engaged in more than one trade or business. It also highlights ancillary consequences that may arise with respect to other Code sections from treating operations as multiple trades or businesses for Sec. 199A purposes.

Defining a trade or business for purposes of Sec. 199A

Regs. Sec. 1.199A-1(b)(14) provides that a trade or business means "a trade or business that is a trade or business under section 162 (a section 162 trade or business) other than the trade or business of performing services as an employee." However, Sec. 162(a) does not provide an explicit definition of what constitutes a trade or business. The preamble to the final Sec. 199A regulations states that the IRS and Treasury declined to establish a bright-line test for determining a trade or business for purposes of Sec. 199A because that specific guidance is beyond the scope of the Sec. 199A regulations. The preamble does discuss, however, two requirements for taxpayers to consider, derived from case law addressing trades or businesses under Sec. 162. First, a taxpayer must enter into and carry on the activity with a good-faith intention to earn a profit. Second, the taxpayer must engage in the activity on a regular and continuous basis (see Groetzinger, 480 U.S. 23 (1987)).

Defining separate trades or businesses

Once an individual or RPE taxpayer determines that it is engaged in a trade or business within the meaning of Sec. 162, the individual or RPE should determine whether its activities constitute one or more trades or businesses. Generally, activities operated in separate taxable entities are considered separate trades or businesses (see Specialty Restaurants Corp., T.C. Memo. 1992-221). However, the IRS and Treasury acknowledge in the preamble that activities within one tax entity also may be treated as separate Sec. 162 trades or businesses (see also Chief Counsel Advice 201430013).

Whether operations are properly treated as separate trades or businesses requires consideration of various factors, derived largely from case law and IRS guidance. The IRS and Treasury received several comments on the proposed regulations suggesting there should be bright-line guidance on how to determine if a taxpayer has one or more trades or businesses. The preamble states that some of the factors suggested by commenters included whether the trades or businesses "have separate books and records, facilities, locations, employees, and bank accounts; operate separate types of businesses or activities; are held out as separate to the public; and are housed in separate legal entities." The IRS and Treasury declined to adopt any of these suggestions, again noting that Sec. 162 is beyond the scope of the Sec. 199A regulations. However, the preamble states that "[t]he Treasury Department and the IRS also believe that multiple trades or business will generally not exist within an entity unless different methods of accounting could be used for each trade or business under [Regs. Sec.] 1.446-1(d)."

Regs. Sec. 1.446-1(d)(1) requires a taxpayer to have separate and distinct trades or businesses to use a different method of accounting for each trade or business. Regs. Sec. 1.446-1(d)(2) provides that "[n]o trade or business will be considered separate and distinct . . . unless a complete and separable set of books and records is kept for such trade or business." Regs. Sec. 1.446-1(d)(3) provides further that trades or businesses will not be considered separate and distinct if, "by reason of maintaining different methods of accounting, there is a creation or shifting of profits or losses between the trades or businesses . . . (for example, through inventory adjustments, sales, purchases, or expenses) so that income of the taxpayer is not clearly reflected" (Regs. Sec. 1.446-1(d)(3)).

In determining whether a taxpayer is engaged in more than one trade or business, courts have identified additional relevant factors. These include (1) whether the two businesses are operated as separate divisions, with separate books of account, employees, management, and other incidents of business; (2) the self-sufficiency of each business; (3) whether the right for the separate division to exist is granted by federal law and regulations; (4) whether assets, books, records, and activities of the two divisions must be segregated under federal law; (5) whether the two divisions have different office space or are located at physically separate locations; (6) whether the clientele of the two divisions are the same or are mutually exclusive; (7) whether one business is a branch of the other business; (8) whether each business has the requisite assets and employees for the production of income; and (9) whether items in common between the two divisions could be shared by any two dissimilar businesses owned by the same taxpayer (see, e.g., Gold-Pak Meat Co., Inc., T.C. Memo. 1971-83; Peterson Produce Co., 313 F.2d 609 (8th Cir. 1963); Nielsen, 61 T.C. 311 (1973); and Rev. Rul. 74-270). The courts' evaluation of these additional factors reflects that maintenance of separate books and records alone is insufficient to treat two lines of business as separate and distinct without the presence of other factors.

The following Example 2 in Regs. Sec. 1.199A-5(c)(1)(iii)(B) illustrates the existence of separate trades or businesses:

Animal Care LLC provides veterinarian services performed by licensed staff and also develops and sells its own line of organic dog food at its veterinarian clinic and online. The veterinarian services are considered to be the performance of services in the field of health under paragraphs (b)(1)(i) and (b)(2)(ii) of [Regs. Sec. 1.199A-5]. Animal Care LLC separately invoices for its veterinarian services and the sale of its organic dog food. Animal Care LLC maintains separate books and records for its veterinarian clinic and its development and sale of its dog food. Animal Care LLC also has separate employees who are unaffiliated with the veterinary clinic and who only work on the formulation, marketing, sales, and distribution of the organic dog food products. Animal Care LLC treats its veterinary practice and the dog food development and sales as separate trades or businesses for purposes of [Secs.] 162 and 199A. Animal Care LLC has gross receipts of $3,000,000. $1,000,000 of the gross receipts is attributable to the veterinary services, an SSTB. Although the gross receipts from the services in the field of health exceed 10[%] of Animal Care LLC's total gross receipts, the dog food development and sales business is not considered an SSTB due to the fact that the veterinary practice and the dog food development and sales are separate trades or businesses under [Sec.] 162.

Although the Sec. 199A regulations do not provide any bright-line factors that will treat an activity as being a separate trade or business, Example 2 provides insightful guidance indicating that activities that (1) separately invoice their customers, (2) maintain separate books and records, and (3) have separate employees that work only in their respective activity may be treated as separate trades or businesses.

Consistency among Code sections in definition

While properly defining separate trades or business has taken on heightened importance for some taxpayers in light of Sec. 199A, this section is one of several Code provisions that look to Sec. 162 to define a trade or business. Taxpayers will want to be consistent in their determination of trades or businesses within their organizations for purposes of all applicable provisions. The preamble states that "[i]n cases in which other Code provisions use a trade or business standard that is the same or substantially similar to the [Sec.] 162 standard adopted in these final regulations, taxpayers should report such items consistently."

For example, as noted above, taxpayers applying the rules under Sec. 199A should consider the trade or business determinations made for their methods of accounting under Sec. 446.

Additionally, proposed regulations under Sec. 163(j) (providing certain interest deduction limitations) refer to Sec. 162 in defining a trade or business (Prop. Regs. Sec. 1.163(j)-1(b)(38)). Trade or business determinations under Sec. 163(j) will have an impact on the allocation of interest expense, interest income, and other tax items between excepted and nonexcepted trades or businesses under that section.

Multiple factors to consider

Activities that constitute separate trades or businesses are not clearly defined in the Code and regulations; hence, determinations largely depend on various factors described in case law and IRS guidance. Taxpayers also should analyze any correlative consequences of defining their trades or businesses for purposes of Sec. 199A, as a failure to do so may result in unintended federal income tax implications under other Code provisions.

Properly defining separate trades or businesses may have a significant effect on the Sec. 199A deduction and should be considered especially in cases in which a taxpayer engages in SSTB activities. Due to the factually based and complex nature of determining whether separate trades or businesses exist, taxpayers should consult with their tax advisers on the application of the various relevant factors to their specific facts and circumstances as well as the overall potential federal income tax impact to their organization.


Annette B. Smith, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, D.C.

For additional information about these items, contact Ms. Smith at 202-414-1048 or

Contributors are members of or associated with PricewaterhouseCoopers LLP.

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