Proposed 199A Regulations Narrowly Interpret “Reputation or Skill” Clause for SSTBs
In a welcome development for owners of passthrough businesses, new proposed regulations under I.R.C. § 199A include a very narrow interpretation of the “catch-all” clause defining specified service trades or businesses.
QBI Deduction and Specified Service Trade or Business
Generally, Section 199A provides a deduction to non-corporate taxpayers of up to twenty (20%) percent of their “qualified business income” (QBI). QBI is income derived from a “qualified trade or business” which is defined as any trade or business other than:
- The trade or business of performing services as an employee, and
- A “specified service trade or business” (SSTB).
Section 199A(d)(2) defined SSTB by reference to Section 1202(e)(3)(A), with certain modifications, so businesses ineligible for the QBI deduction include:
…any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. (emphasis added).
“Reputation or Skill” Catch-All
The last clause was of great concern because many businesses clearly outside the scope of any of the specifically listed categories could nonetheless find themselves captured by the catch-all and thus precluded from taking the QBI deduction. For example, if a local restaurant hires last season’s winner of Top Chef as its executive chef, arguably its principal asset is the skill and reputation of one of its employees. Thus, the restaurant owner could be ineligible for the QBI deduction.
An even broader interpretation could encompass virtually every service business. However, the Treasury Department and IRS explicitly rejected such a broad interpretation: “If the ‘reputation or skill’ clause was intended to exclude all service businesses from section 199A, there would have been no reason to enumerate specific types of businesses in section 199A(d)(2); that language would be pure surplusage.”
This alone was a very favorable development, but the Treasury Department went several steps further and proposed an interpretation that will likely affect only a small number of taxpayers.
Interpretation under the Proposed Regulations
Under the proposed regulations, only the following trades or businesses will be treated as having their principal asset as the skill or reputation of its employees/owners:
- A trade or business in which a person receives fees, compensation, or other income for endorsing products or services,
- A trade or business in which a person licenses or receives fees, compensation, or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity, or
- Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
An example provided in the proposed regulations is instructive:
Example 8. H is a well-known chef and the sole owner of multiple restaurants each of which is owned in a disregarded entity. Due to H’s skill and reputation as a chef, H receives an endorsement fee of $500,000 for the use of H’s name on a line of cooking utensils and cookware. H is in the trade or business of being a chef and owning restaurants and such trade or business is not an SSTB. However, H is also in the trade or business of receiving endorsement income. H’s trade or business consisting of the receipt of the endorsement fee for H’s skill and/or reputation is an SSTB within the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section.
This example makes clear that, while H cannot take the QBI deduction against his endorsement income, H can take a QBI deduction against his income earned from the restaurants, even though his skill/reputation is likely a major factor in revenue generation. Instead, H’s endorsement and licensing income is carved out and treated as income from an SSTB, while the remainder is still eligible for the QBI deduction.