The Tax Cuts and Jobs Act passed in late 2017 brought a host of changes to the US tax code. The change that inspired the biggest buzz and perhaps the most confusion is the new 20 percent deduction of Qualified Business Income (QBI) for specified passthrough companies. Government contractors – along with their tax advisors – have been poring over the updated tax code ever since in an attempt to determine whether they can take advantage of this significant tax break.
That’s because while the new 199A QBI deduction is certainly appealing, it’s not available to everyone. The IRS included a number of limitations on who qualifies for the deduction as well as some grey areas in how the law should be interpreted, leaving business owners and accountants thirsty for additional guidance.
Following limited clarifications in 2018, the IRS issued final regulations and additional guidance related to the QBI deduction in January of 2019, along with proposed regulations not yet finalized. Although the new guidance is both welcome and helpful, many government contractors remain uncertain of whether they can claim the deduction or not.
The 20 percent deduction does not apply to a Specified Service Trade or Business (SSTB). For the purposes of the new law, an SSTB is a trade or business that provides any of the following services: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investment and investing management, trading, dealing in securities, or any business where the principal asset is the reputation or skill of one or more of its employees or owners [Treas. Reg. 1.199A-5(b)(1)].
Government contractors often include consulting as a component of their services, making it difficult to determine if the business qualifies for the deduction. In many cases, a closer look at the definitions and exceptions included in the final and proposed regulations can help clarify the issue for these businesses.
The IRS regulation defines consulting (in this context only) as “the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems.” Additionally, it specifies that “the performance of services in the field of consulting does not include the performance of services other than advice and counsel” such as sales (or economically similar services) or the provision of training and educational courses.
In assessing the applicability of the deduction, government contractors should be aware that a business can provide some consulting services without being automatically defined as an SSTB and, as a result, barred from claiming the QBI deduction.
The final regulations state that “performance of services in the field of consulting does not include the performance of consulting services embedded in, or ancillary to, the sale of goods or performance of services on behalf of a trade or business that is otherwise not an SSTB (such as typical services provided by a building contractor) if there is no separate payment for the consulting services.”
To prevent a single SSTB transaction from disqualifying the entire trade or business from the 199A deduction, the IRS also provides a de minimis exception to taxpayers. For trades or businesses with less than $25 million in gross receipts, an activity will not cause the trade or business to be classified as an SSTB if less than 10 percent of the gross receipts are attributable to the performance of services in one of the prohibited fields. If the trade or business has gross receipts greater than $25 million, the de minimis exception is reduced to 5 percent of the gross receipts. [Treas. Reg. 1.199A-5(c)(1)]
Understanding the 199A QBI deduction and how to properly apply it is a challenging endeavor, to be sure. Government contractors should seek expert professional assistance in interpreting and applying this aspect of the tax code. However, they can take comfort in the clear fact that providing consulting services does not necessarily prevent them from qualifying for this valuable tax deduction.
To learn more about the new 199A QBI deduction and other tax savings opportunities that may be available to your government contracting business, talk to the tax professionals at Halt, Buzas & Powell today. We’ll help you navigate the maze of IRS rules and regulations to minimize your tax liability while keeping you in full compliance with the law – no matter how complicated.
Written by Chris Davidson; Tax Manager