Personal service businesses are trades or businesses where the principle asset of the business is the reputation or skill of one or more of the employees of that business. These personal service businesses are defined as a business whose primary activity involves accounting, actuarial services, architecture, brokerage services, consulting, engineering, financial services, health, medical and veterinary services, law, performing arts, or athletic endeavors. A business whose primary activity is to prepare tax returns would be a personal service business. Such businesses have historically been subject to special provisions in the tax code.
With the passage of the Tax Cuts and Jobs Act, Congress enacted new rules affecting service businesses. For example, under pre-TCJA, a corporation that was deemed to be a Personal Service Corporation (“PSC”) filing Form 1120 was taxed at a different rate than other corporations filing Form 1120. However, the TCJA changed that provision and now a PSC is taxed at 21% which is the same rate all other corporations filing Form 1120 are assessed.
The new Qualified Business Income Deduction (“QBID”), also has provisions that only apply to certain personal service businesses which are classified as Specified Service Trades or Businesses, (“SSTB”). Architects and engineers are not subject to these additional QBID provisions and are not classified as a SSTB, but all other personal service trades or business are. Detailed definitions of what the IRS has deemed constitutes a SSTB can be found in Publication 535, which is currently only available in draft form at the IRS draft forms website.
For any personal service business which is classified as a SSTB, the QBID will be limited once the taxpayer’s income reaches the threshold amounts of $315,000 for Married Filing Jointly or $157,500 for all other filing statuses. When this occurs, the QBID for that business is phased-out, and the deduction is eventually eliminated if the taxpayer’s income rises to $415,000 for Married Filing Jointly or $207,500 for all other filing statuses.
The phase-out reduction of the QBID for a SSTB is based on the extent taxable income exceeds the threshold amount and the QBID is reduced by that percentage. For example, if a taxpayer’s business is a SSTB and taxable income exceeds the threshold amount by 35%, then the QBID for that SSTB will be reduced by 35%. This phase-out reduction is calculated on Worksheet 12-A, Schedule A which can be found in Publication 535. In the 2018 tax program, Worksheet 12-A, Schedule A will only be applicable if the business is designated as a Specified Service Trade or Business.
For any SSTB below the income thresholds, the QBID is treated exactly in the same manner as it would be calculated for any other pass-through business.