Choice of Entity Corner
The term “specified service trade or business” (“SSTB”) for purposes of Code Sec. 199A means any trade or business “which is described in section 1202(e)(3)(A) (applied without regard to the words ‘engineering, architecture,’) or which would be so described if the term ’employees or owners’ were substituted for ’employees’ therein.”1 This modified version of the Code Sec. 1202 term “qualified trade or business” (“QTB”) includes 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.2
While Code Sec. 1202 is the source of the definition of SSTB under Code Sec. 199A, neither the Code language nor regulations under Code Sec. 1202 offer any further insights as to what constitutes the “field of health.” Moreover, the few private letter rulings under Code Sec. 1202 specific to healthcare activities are fairly conclusory, with little in the way of analytical detail.3 However, the legislative history behind Code Sec. 199A suggests that Code Sec. 1202 may not be where the action really is.
Code Sec. 199A and Its Legislative History
The Joint Explanatory Statement issued to the House and Senate with respect to the Tax Cuts and Jobs Act of 2017 (“TCJA”) examines the term SSTB as used in Code Sec. 199A. The Conference Committee specifically observed that “[a] similar list of service trades or business is provided in section 448(d)(2)(A) and Treas. Reg. sec. 1.448-1T(e)(4)(i)”—defining the term “qualified personal service corporation” (“QPSC”).4
A QPSC is defined to include, among other things, any corporation substantially all of the activities of which involve the performance of services in the “field of health.”5 The temporary regulations under Code Sec. 448(d)(2)(A) (the “Temporary 448 Regulations”) provide that the performance of services in the “field of health” means the provision of medical services by physicians, nurses, dentists, and other similar healthcare professionals.6 However, the performance of services in the field of health does not include the provision of services that are not directly related to a medical field—even though the services may purportedly relate to the health of the service recipient.7
The Joint Statement quotes the Temporary 448 Regulations at some length, and specifically notes the clarifying example that the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers.8 In so doing, the legislative history to Code Sec. 199A clearly points to the Temporary 448 Regulations as a vein of interpretive guidance.
Final 199A Regulations
The Final 199A Regulations provide that, for purposes of defining an SSTB, the performance of services in the “field of health” means “the provision of medical services by individuals such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals performing services in their capacity as such.”9
This formulation appears to present a three-prong test that is similar—but not entirely identical—to the two-pronged test for what constitutes a QPSC under the Temporary 448 Regulations.
First, the services must be “medical services”—as is the case under the Temporary 448 Regulations. Second, the services must be provided by “individuals such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals”—as is also the case under the Temporary 448 Regulations. But the Final 199A Regulations appear to add a third, distinct prong: The “healthcare professionals” providing the “medical services” in question must be doing so “in their capacity as [healthcare professionals].”
The distinction created by this “third prong” appears, at first, to be more theoretical than practical—as it is difficult to envision a setting in which a “healthcare professional” would be providing a “medical service” other than in his or her capacity as such. However, one example of such a setting—and it appears in the Treasury’s response to comments on the proposed 199A regulations—may be pharmacies.10
Finally, it bears noting that, like the Temporary 448 Regulations, the Final 199A Regulations also clarify that the performance of services in the “field of health” does not include the provision of services that are not directly related to a medical services field—even though such services may purportedly relate to the health of the service recipient, stating:
For example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers, payment processing, or the research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.11
Note that this formulation is even more expansive than that of Reg. §1.448-1T(e)(4)(ii) of the Temporary 448 Regulations, in that it further explicitly excepts out “payment processing, or the research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.”
Guidance on What Constitutes the “Field of Health” Under Code Sec. 448
While the Final 199A Regulations provide four healthcare specific examples, they are somewhat conclusory and offer little detailed analysis. However, there are some notable cases and IRS guidance regarding what constitutes a QSPC in a variety of healthcare settings. These merit consideration, because the conceptual mechanics are set out in greater detail, and can be more easily extrapolated and applied to other settings.
TAM 9222004 (Jan. 8, 1992)
TAM 9222004 addresses the question of whether a taxpayer engaged solely in the business of providing physical therapy services is a QPSC under Code 448(d)(2), and therefore required to use the personal service corporate tax rate contained in then Code Sec. 11(b)(2).12 The short answer was “yes.” Inasmuch as the Final 199A Regulations (unlike the Temporary 448 Regulations) clearly identify “physical therapists” as engaging in an activity within the “field of health,” this Memorandum would seem to have little to offer by way of additional guidance. However, the detailed reasoning employed to reach this conclusion is extremely instructive—and may be comparable to the analysis that might be employed to determine the application of the Final 199A Regulations to healthcare adjacent activities that are not clearly identified as SSTBs.
To begin, the taxpayer at issue in TAM 9222004 was solely engaged in the business of providing physical therapy services—including “the evaluation, treatment, instruction, and administration of physical therapy services for the purpose of assessing, preventing, correcting, or alleviating a client’s physical pain through the use of massage, exercise, instruction, and the use of equipment.” Per applicable state law, the taxpayer could only obtain its clients through a physician’s referral or prescription. The physician in question would make the initial examination and diagnosis of the client, and the physical therapists would provide the services prescribed by the physician.
The taxpayer argued that, because a client’s diagnosis is made by a physician—and that taxpayer was unable to prescribe medication—the taxpayer does not provide medical services. However, the examining agent argued that it was precisely because the physical therapy services were prescribed by a physician that the taxpayer did, in fact, provide medical services—and, as such, was a QPSC in the “field of health.”
The General Counsel observed at the outset that, neither the Code nor the regulations provide a clear definition of what constitutes “medical services” for purposes of Reg. §1.448-1T(e)(4)(ii). However, the General Counsel concluded that Code Sec. 213 was an appropriate source of guidance in this regard.
The regulations under Code Sec. 213 define medical care to include the “diagnosis, cure, mitigation, treatment, or prevention of disease.”13 Additionally, the applicable law of the taxpayer’s state of residence defined “physical therapy” as the “evaluation, treatment, instruction, and administration of services to assess, prevent, correct, or alleviate the signs and symptoms of physical disability and pain.”14 Thus, while state law required that the initial diagnosis be performed by a physician, a physical therapist was nevertheless still responsible for the “cure, mitigation, treatment, and prevention of its clients’ pain and disabilities.”15
The regulations under Code Sec. 213 also provide that amounts paid for “therapy” are deemed to have been paid for purposes of medical care.16 Because “therapy” services were medical care within the meaning of the regulations under Code Sec. 213, the General Counsel concluded that the physical therapy services provided by the taxpayer to its clients were medical services for purposes of Reg. §1.448-1T(e)(4)(ii).
However, this was not the end of the analysis. The second prong of the test under the Temporary 448 Regulations further requires that the “medical services” be provided by a “health-care professional.”17 Again, the General Counsel noted that neither the Code nor the regulation defines the term “healthcare professional,” but concluded that the taxpayer’s physical therapists were nevertheless “similar” to the health-care professionals specifically identified in the regulations in terms of education, training, and the very nature of its services, noting:
[T]he very nature of a physical therapist’s services is to provide evaluation, treatment, instruction, and administration of physical therapy services for the purpose of assessing, preventing, correcting, or alleviating physical disability or pain. Unlike a health spa or a health club that provides physical exercise or conditioning to its customers, physical therapy services are more than merely related to the health of the service recipient. In fact, physical therapy services are for the specific treatment of a physical ailment. Thus, the very nature of the taxpayer’s services are similar to the services provided by other health-care professionals such as physicians, nurses, and dentists.
TAM 9309004 (Nov. 23, 1992)
This Memorandum considered the question of whether a taxpayer, whose employees performed emergency medical ambulance services, was a QPSC. The taxpayer in question employed a large ambulance field force of emergency medical technicians (“EMTs”)—70 percent of whom had advanced training (“Advanced Technicians”) and 30 percent of whom had lesser training (“Technicians”). Based on the volume of services provided by its staff, the taxpayer would only be considered a QPSC if its Technicians were deemed to be performing services in the “field of health.”
The Technicians performed medically related services on all manned hospital ambulance transports and were in direct radio contact with hospital emergency room physicians. This was true even for non-emergency calls. Because the services provided by the Technicians were “similar” to those of the listed healthcare professionals identified in the Temporary 448 Regulations, the General Counsel concluded that Technicians provide medical services. Again, however, this was not the end of the analysis. The second question was whether the Technicians were “healthcare professionals.”
The Technicians were licensed and certified pursuant to the state law, and had to pass a variety of competency tests to obtain and maintain such certification. Moreover, the core function of the Technicians was to provide basic medical services during ambulance transit. In this respect, the General Counsel concluded that the Technicians were trained to perform medical services in this narrow medical area “at least as well as most licensed physicians and nurses other than the small segment of the licensed physicians and nurses specializing in the field of emergency medicine.” (Emphasis added.) Against this background, the General Counsel held that the Technician’s services were similar to the services provided by other health-care professionals such as physicians and nurses.18 As such, the taxpayer was a QPSC.
Chickasaw Ambulance Service, Inc.
In Chickasaw Ambulance Service, Inc.,19 the District Court for the Northern District of Iowa (in an unpublished opinion) also considered the question of whether an ambulance service constituted a QPSC—but reached the opposite conclusion of TAM 9309004. In so doing, the court engaged in a lengthy analysis of the second prong of the QPSC test (i.e., whether the medical services in question were provided by a “healthcare professional”). Both the taxpayer and the government cited various provisions of state and federal law in support of their arguments about what constitutes a “professional.” However, unlike the General Counsel in TAM 9309004, the court in Chickasaw found these references to other applicable law unavailing, and not a useful definition of the term “professional” for tax purposes.
To begin, the court in Chickasaw began by observing that the term “professional” is subject to differing, reasonable interpretations.20 However, in the context of the Temporary 448 Regulations the court concluded that the term “conveys the need for advanced education and intellectual training ‘similar’ to physicians, nurses, and dentists.”21
Although some of the EMTs at issue were required to have substantial training and clinical experience, they were not required to have a high school diploma or equivalent—let alone any college or postgraduate degrees.22 Furthermore, in the court’s view, the record demonstrated that “emergency medical services is not a profession dominated by mental or intellectual job requirements.” Specifically, the court noted that the taxpayer (i) frequently performed “stand-by services at high school football games, tractor pulls, county fairs, and other area events which did not require the provision of professional medical services”; (ii) transported five to 10 corpses a year; (iii) estimates that between 18 percent and 26 percent of its runs “involved nothing more than taking a patient’s pulse and transporting the patient to the hospital”; and (iv) sometimes drove patients from nursing homes to hospitals because the patients were physically incapable of riding in an automobile.23 While such services may be incidental to the provision of professional medical services at the hospital, the court concluded that they did not involve the performance of “professional” medical services by Chickasaw as defined under Reg. §1.448-1T(e)(4)(ii).24
Ultimately, however, the Chickasaw court’s decision really seems to have come down to a policy judgment about the wisdom of taxing ambulance companies at the higher, flat tax of a QPSC like a regular medical practice. While neither party appears to have argued this point, or cited any legislative or regulatory history regarding QPSCs, the Chickasaw court ruled that excluding the taxpayer from the scope of the defined term QPSC was supported by the Congressional purpose in taxing QPSCs at a higher flat rate, rather than the lower graduated tax rates which apply to other corporations—noting:
Although this legislative history is relatively sparse, commentators have explained that Congress intended “professionals and certain other personal service providers who desire to provide their services in corporate form to be treated for tax purposes as if they were providing their services as partners or individuals.”25
In the court’s view, these legislative purposes suggested that the phrase “other similar healthcare professionals” should be interpreted narrowly in order to protect companies performing personal services in the field of health which were not trying to use their corporate structure to avoid paying the higher individual income tax rates they would otherwise pay if not incorporated. The court believed that, unlike a physician’s office, an ambulance service company is not the type of business which is ordinarily operated by individual proprietors or partnerships. Moreover, an ambulance service company may have a greater need to accumulate capital than physicians, nurses, or dentists for the purchase of ambulances and other equipment.
Accordingly, the court concluded that EMTs were not professionals within the meaning of Reg. §1.448- 1T(e)(4)(ii).
In Eure, the Tax Court had occasion to address the question of whether a radiation oncology treatment facility was a QPSC.26 The taxpayer in Eure stipulated that it was established as a professional medical corporation and had reported on the returns for the years at issue that it was engaged in the “practice of medicine.” Thus, the first prong of the QPSC test under the Temporary 448 Regulations seemed clearly to have been satisfied. However, the taxpayer argued that, because it was a facility and not a person, it could not provide “personal” services. However, the court flatly rejected this contention as contrary to Code Sec. 448 and the regulations promulgated thereunder— which plainly define a QPSC as a corporation whose employees perform services in a qualifying field.
Second, and in a variation of the first claim, the taxpayer argued that it operated a treatment facility which was in the business of “creating and containing radiation,” rather than a healthcare facility. However, the Eure court concluded that the employees of taxpayer’s radiation therapy treatment facility were, in fact, rendering services in the “field of health” because they were treating cancer patients’ healthcare needs by the provision of radiation therapy.
Next, the taxpayer argued that its radiation technicians rendering services should not be considered in determining whether substantially all of its time is spent providing healthcare services. In the taxpayer’s view, the radiation technicians were not “professionals” within the meaning of the Temporary 448 Regulations. The court disagreed, and specifically distinguished the decision in Chickasaw (discussed above) on the grounds that the taxpayer in Chickasaw was actually able to prove that its EMTs could perform their jobs without high school diplomas—while the taxpayer in Eure failed to prove that its radiation technicians could perform their jobs without advanced education and intellectual training similar to what is required of physicians, nurses, or dentists. (Having concluded that the radiation technicians were “professionals” similar to physicians, the Eure court did not take up the policy argument advanced by the Chickasaw court regarding the Congressionally intended scope of the higher, flat tax on QPSCs.)
Finally, the taxpayer argued that the time its radiation technicians spent maintaining and operating the radiation equipment should not be considered as time spent performing services in the healthcare field. The taxpayer alleged that this “equipment” time amounted to at least 10 percent of the employees’ total time performing services and, as such, should not result in a finding that substantially all (i.e., 95 percent) of its time was spent on services in the healthcare field.
It should be noted that this “substantially all” aspect of the test for QPSC status under the Temporary 448 Regulations is not applicable to the test for whether an activity is an SSTB for purposes of Code Sec. 199A—which does not have a temporal component. Nevertheless, the Eure court’s decision on this point merits attention because it essentially treated such equipment maintenance and operation as an activity in the “field of health.” Specifically, the court held that the time taxpayer’s radiation technicians spent maintaining and operating its radiation equipment was not only incident to, but integral to, the overall provision of radiation therapy to the taxpayer’s patients. Accordingly, time spent operating the radiation equipment was effectively “time spent performing services in the healthcare field.”
In Zia-Ahmadi, the Tax Court considered (among a number of tax questions) whether an ultrasound clinic was a QPSC.27 The taxpayer in Zia-Ahmadi claimed that its employees who operate the ultrasound equipment (sonographers) did not perform services in the “field of health,” because such sonographers (i) were not required to be licensed under applicable state law, (ii) did not provide direct treatment services to patients, and (iii) did not make healthcare decisions.
However, the Tax Court observed that it has consistently held that QPSC status does not turn on state licensing laws.28 Rather, whether a particular service is performed in one of the qualifying fields “is to be decided by all relevant indicia, including the text of the statute, its legislative history and regulations, application of the normal meaning of the term ‘health’ … and examination of services historically regarded as within the qualifying field.”29
The taxpayer argued that none of its employees should be considered “healthcare professionals” because they were not subject to any “minimum requirements” for the provision of ultrasound services. However, the principal of the taxpayer testified that he had attended and completed a two-year ultrasound associate program and worked at a hospital for a few years performing ultrasound services before founding his own ultrasound clinic. Moreover, the principal was the only employee to perform the ultrasound activities for the years in issue.
Additionally, the taxpayer’s professional service agreements expressly stated that taxpayer “contracts and employs licensed medical professionals.” These service agreements also stated that taxpayer would “obtain and maintain accreditation with, among other organizations, the American College of Radiology, a professional medical society.”
Against this background, the Tax Court concluded that sonographers were healthcare professionals that performed services in the qualifying field of health.
While the definition of SSTB nominally has its origins in Code Sec. 1202, the legislative history of Code Sec. 199A makes clear that the Temporary 448 Regulations should be regarded as an appropriate source for guidance in construing this term. With the elimination of the higher, flat rate of tax on QPSCs under the TCJPA’s revisions to the C-Corporation rates, it is likely that there will be fewer instances of court and agency guidance on what constitutes a QPSC for this purpose. However, given the similarities between the Temporary 448 Regulations and the Final 199A Regulations, the analysis of what constitutes a QSPC should have continued vitality for purposes of Code Sec. 199A.
1 Code Sec. 199A(d)(2)(A).
2 Code Sec. 1202(e)(3)(A) (omitting the words “engineering” and “architecture”).
3 See LTR 201436001 (May 24, 2014) and LTR 201717010 (Jan. 23, 2017). Note: LTR 201717010 bears a striking resemblance to Example 4 under the Final 199A Regulations. Cf. Reg. §1.199A- 5(b)(3)(iv).
4 Joint Explanatory Statement of the Committee of Conference on H.R. 1, 115th Cong. 1st. Sess. (2017) (hereinafter Joint Statement), 30–31, n. 44.
5 Code Secs. 448(b)(2) and (d)(2)(A).
6 Reg. §1.448-1T(e)(4)(ii).
8 See Joint Statement at 30–31, n. 44 (citing Reg. §1.448-1T(e)(4)(ii)).
9 Reg. §1.199A-5(b)(2)(ii).
10 In response to several comments regarding the application of the regulations to pharmacists, Treasury and the IRS signaled their agreement that the sale of pharmaceuticals and medical devices by a retail pharmacy is not by itself a trade or business performing services in the field of health. See 84 FR 2952, 2971. However, the response to commenters noted that some services provided by a retail pharmacy through a pharmacist would constitute the performance of services in the field of health—and the final regulations provide the following example:
Example 1. B is a board-certified pharmacist who contracts as an independent contractor with X, a small medical facility in a rural area. X employs one full time pharmacist, but contracts with B when X’s needs exceed the capacity of its full-time staff. When engaged by X, B is responsible for receiving and reviewing orders from physicians providing medical care at the facility; making recommendations on dosing and alternatives to the ordering physician; performing inoculations, checking for drug interactions, and filling pharmaceutical orders for patients receiving care at X. B is engaged in the performance of services in the field of health within the meaning of Code Sec. 199A(d)(2) and paragraphs (b)(1)(i) and (b)(2)(ii) of this section.
See Reg. §1.199A-5(b)(3)(i). Thus, it would appear that retail pharmacy sales by a pharmacy that is simply owned by a pharmacist might be an instance where a “healthcare professional” is providing a “medical service” other than in his or her capacity as such.
11 Reg. §1.199A-5(b)(2)(ii).
12 TAM 9222004 (Jan. 8, 1992).
13 Reg. §1.213-1(e)(1)(i).
14 TAM 9222004.
16 Reg. §1.213-1(e)(1)(ii).
17 Specifically, Reg. §1.448-1T(e)(4)(ii) requires that the medical services are provided by physicians, nurses, dentists, or other “similar health-care professionals.” (Emphasis added.)
18 See TAM 9309004 (Nov. 23, 1992).
19 Chickasaw Ambulance Service, Inc., 1999 WL 33656862 (May 21, 1999).
20 Id., at *5.
21 Id. (citing Black’s Law Dictionary (5th ed. 1979) for the propositions that (i) a “profession” is “a vocation or occupation requiring special, usually advanced, education and skill,” and (ii) “[t]he labor and skill involved in a profession is predominantly mental or intellectual, rather than physical or manual.”) (Emphasis added.)
23 Id., at *7.
25 Id., at *6 (quoting Morton A. Harris, Special Concerns and Planning Opportunities for Personal Service Corporations, ALI ABA Course of Study: Qualified Plans, PCs, and Welfare Benefits, 255, 281 (American Law Institute 1992) (reproduced on Westlaw as “C724 ALI ABA 253”)).
26 W.W. Eure, 93 TCM 1237, Dec. 56,938(M), TC Memo. 2007-124 (May 18, 2007).
27 Tax Court Summary Opinion 2017-39 (June 14, 2017).
28 Id. (citing Kraatz & Craig Surveying, Inc., 134 TC 167, 181, Dec. 58,178 (2010)).
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