A new example in the final section 199A regulations is generating a lot of discussion and interest because it indicates that under certain facts and circumstances, surgical center income could be qualified businesses income (QBI) and eligible for the section 199A deduction. This is a notable example because income from so called Specified Service Trades or Businesses (SSTB), including income from services performed in the field of health, is generally not eligible for the section 199A deduction.
Even though a reasonable reading of the statute indicates that income from traditional health care services, like income from a physician practice, is income from a SSTB, many commentators and taxpayers have questioned whether businesses related to a SSTB are also considered a SSTB by reason of the relationship. For example, if a physician practice owns an ambulatory surgical center that charges a facility fee, is that fee QBI or is it income from a SSTB? In response to these questions, the Treasury Department and IRS included the new surgical center example. However, while this example appears straight forward, its nuances and practical application could produce varying results depending on particular facts and circumstances.
A Surgical Center Example
We’ve condensed the facts for the purposes of this Insight:
A private organization owns a number of outpatient surgical centers that do not require overnight patient stays. The organization provides certain management and regulatory services but does not employ any physicians, nurses, or medical assistants. Instead, the organization enters into agreements with other professional medical organizations or directly with medical professionals to perform procedures and provide medical care. These other professional organizations or medical professionals directly bill the patients for all medical services. The private organization bills the patients for a facility fee. Based upon these facts, the example concludes that the organization “does not perform services in the field of health within the meaning” of section 199A, meaning its income is QBI.
Key Factual Distinctions
Many owners of surgical centers may first read this example and assume their center generates QBI. Yet upon closer inspection, these same owners may become less comfortable when realizing their facts do not materially match the facts of the example. For instance, under state law, a surgical center may be required to have a certain number of nurses on the premises, and this could necessitate directly employing nurses. Also, surgical centers can sometimes be housed in the same regarded entity (for tax purposes) as the physician practice, and the entity may have treated both activities as a single business for tax purposes (a single tax return) in previous years. Given these (and likely other) real-world factual differences from the surgical center example, the actual application of this example may not prove to be quite as helpful as first anticipated.
A Possible Purpose
It seems probable the IRS knows that the facts of the surgical center example do not necessarily match the facts of the typical surgical center. For instance, the IRS is likely aware that surgical centers often employ nurses. So why did the IRS provide the example? One interpretation is that the IRS was only recognizing that surgical center income unrelated to any type of medical services could be QBI. The preamble to the final regulations states, in part, that the new surgical center example demonstrates “a fact pattern that the Treasury Department and the IRS do not believe is a trade or business providing services in the field of health.” In other words, the purpose of the example could be to illustrate a point and not necessarily to represent a real-world fact pattern. Although this may prove frustrating for taxpayers and practitioners, it is important to remember that IRS guidance is often intended to express rules and principles rather than provide exact answers to questions for specific business situations.
Next Steps for Surgical Centers
Owners of surgical centers trying to determine eligibility for the section 199A deduction may want to consider several issues. First, the final section 199A regulations affirmed that even a small amount of revenue from health services can taint an entire business. For example, if a surgical center has gross receipts of $25 million or under, and 10 percent or more of the gross revenue comes from health services, the IRS views the entire business as being a SSTB. The threshold decreases to 5 percent for businesses with gross receipts over $25 million. Based upon this, if a surgical center employs nurses, it may need to determine what percentage of the facility fee charged to patients is attributable to the nurses given that a portion of the fee may cover the nurses’ salaries. This could introduce new compliance costs because many surgical centers may not track this level of detail. Other options could involve housing all medical professionals in a distinct legal entity separate and apart from the surgical center. Or it may be possible to argue that any health services represent a business separate and apart from the surgical center business.
These considerations stand in contrast to other guidance focusing on a physician investor’s involvement (or non-involvement) in a surgical center. As opposed to some of this other guidance, section 199A is not necessarily focused only on a physician investor’s involvement, and is instead focused on whether any health services are performed as part of a business, no matter if those services are performed by a physician or other medical professional, such as a nurse.
The Importance of Understanding Tax Reform and 199A
The new surgical center example is certainly interesting, but well-advised taxpayers may consider exercising caution before relying upon the example, particularly because there are enhanced penalties under section 199A. Additionally, taxpayers and practitioners would be advised to carefully consider the purpose of this new example before coming to any firm conclusions on its application.
199a has numerous complexities.