TAX REFORM: IRS Limits Tax Strategies for Pass-Through Healthcare Entities

On August 8^th, the IRS released proposed regulations addressing the Section 199A deduction, commonly known as the 20 percent pass-through deduction. The guidance clarified several aspects of Section 199A that are of particular interest to healthcare providers, including the definition of “specified service trades or businesses” (SSTBs) and restrictions on splitting up existing businesses. At first glance, it appears that these new rules will limit the ability of healthcare professionals to qualify for the deduction. (For a broader look at the general impact of the proposed regulations, see the HORNE article, “Tax Reform: Guidance For Pass-Throughs Is Here.”)

When the Tax Cuts and Jobs Act (TCJA) passed in December 2017, it stated that taxpayers providing “healthcare” services were not eligible for the 20 percent pass-through deduction, unless their income is under certain limits. The regulations confirm that entities providing healthcare services are among the SSTBs that are specifically excluded from benefitting from the full amount of the deduction. Under the proposed regulations, the performance of services in the field of health includes medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists and other similar healthcare professionals who provide care directly to a patient.

The guidance goes on to specify that taxpayers can generally rely on the existing definition of “personal services” under prior rules for personal service corporations. Generally speaking, those rules hold that most clinics employing nurses or physicians will be defined as SSTBs. It’s important to note that tax court rulings under the personal service corporation regulations, found that even companies who do not directly serve patients can be considered as providers of healthcare services. One specific court case found that an ultrasound company would be considered to provide healthcare services, even though they did not directly treat patients. As a result, healthcare practices that provide services both directly and indirectly to patients will have very little leeway when it comes to getting around this exception.

The guidance also limits the ability of healthcare providers to split their businesses into component parts in order to take advantage of the 20 percent deduction for some aspects of the practice. If an SSTB owns 50 percent of an enterprise, the controlled entity is also going to be considered an SSTB to the extent the services and/or rentals are provided directly back to the original business. The proposed regulations provide an example of a dentist who owns a practice and a building. He rents the building 50 percent to his dental practice and 50 percent to an outside party. The 50 percent rented to his practice will be considered SSTB.

Some physicians, with income under the SSTB limits, have considered becoming independent contractors in order for their earnings to qualify as pass-through earnings under Section 199A. The proposed regulations make it clear that any such change in employment status would need to comply with the relatively complex rules governing the determination of employee/independent contractor status. This won’t make it impossible for physicians to meet the test, but this standard will require significant changes to the relationship between the physician and the practice.  Unless there are considerable changes to the services provided and the costs incurred by the medical professional, changing an employee to an independent contractor won’t pass the scrutiny of the IRS.

Even though these rules limit the availability of the 20 percent deduction for medical professionals, there are still many provisions in the TCJA that allow for significant tax planning opportunities for healthcare entities. This blog is the first in a series that will address these provisions and their impact on the healthcare sector. We will be exploring how the TCJA altered deductions for depreciation, meals, parking and entertainment.

We will also be closely watching for any additional IRS clarifications concerning areas of interest for healthcare entities. Consult with your HORNE LLP tax advisor for how these proposed regulations will specifically affect you and be on the lookout for our next blog in this series.