This week, I talk about physician 199A deductions.
More specifically, I talk about how many physicians who own part or all of their medical services practices can take the Section 199A deduction.
Yes, I know. The law and the regulations lead you to conclude otherwise. But many physicians can use the 199A deduction.
And for one of three reasons: their taxable income falls or can be pushed below the thresholds… or they can use separate financial records to cull out qualified business income amounts … or in some special cases because what the physician does doesn’t count as specified service trade or business.
But let’s start with a quick review.
First The 199A Deduction in a Nutshell
The 199A deduction works like this. Someone who earns income from a sole proprietorship, partnership or S corporation gets a deduction equal to (potentially) 20 percent of the “qualified business income.”
Basically? The qualified business income equals the amount shown on the Schedule C or the K-1 from the partnership or S corporation.
For example, someone who earns $100,000 as a self-employed physician probably gets a $20,000 199A deduction. Someone who earns $200,000 maybe gets a $40,000 deduction. Someone who earns $1,000,000 might get a $200,000 deduction.
And then I should mention a couple of bookkeeping glitches. First, some business expenses (like for a pension or self-employed health insurance) don’t get counted on the Schedule C or on the partnership or S corporation tax return. So you have to adjust the Schedule C or K-1 number.
The other bookkeeping glitch. Not all of the income that shows up on a K-1 counts as qualified business income. Pretty much, only what shows in box 1.
Warning: I’m cutting some corners here and skipping over some details. But if you need more precise information, don’t worry. We’ve got a bunch of 199A articles here at the blog. And for people who just can’t get enough, you can even purchase and download a copy of our “Maximizing Section 199A Deductions” e-book.
The Rub for Physicians
The only problem with a physician taking the Section 199A deduction? The law and related regulations say you lose the deduction if you earn your business income providing medical services and taxable income rises too high.
The exact language comes from the final regulation and is worth quoting here with the critical phases italicized and boldfaced:
(ii) Meaning of services performed in the field of health. For purposes of section 199A(d)(2) and paragraph (b)(1)(i) of this section only, 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. The performance of services in the field of health does not include the provision of services not directly related to a medical services field, even though the services provided may purportedly relate to the health of the service recipient. 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.
And this other bit. The income level that causes a physician to lose the deduction? For 2020, the physician taxpayer loses her or his deduction as taxable income rises from $326,600 to $426,600 for joint filers, and from $163,300 to $213,300 for single filers.
Note that the law phases out the deduction as taxable income moves through the ranges just given. Accordingly, once a married taxpayer’s taxable income exceeds $426,600 or a single taxpayer’s taxable income exceeds $213,300, boom, no Section 199A deduction.
The Three Ways Physicians Salvage Section 199A Deduction
Now that you’ve got that background, let’s talk about how a physician can usually take the Section 199A deduction on at least some and maybe all of their business income.
As mentioned, a physician enjoys roughly three ways to salvage the Section 199A deduction.
Income Below or Pushed Below Thresholds
The first way? Which is obvious probably? When the physician’s taxable income falls below the thresholds.
For example, a single taxpayer making (say) $163,300 or less as a sole proprietor? She or he gets the Section 199A deduction. Even if the “business” provides “medical services.”
The same thing happens with a married taxpayer making $326,600. She or he gets the Section 199A even if the “business” provides “medical services.”
Remember too that the phaseout law looks at taxable income. Accordingly, if someone saves, say, $20,000 into a 401(k) and tallies up $30,000 of Schedule A “itemized deductions,” those deductions create space.
With $50,000 of tax deductions, a single taxpayer doesn’t start losing the 199A deduction at $163,300 of business income. And a married taxpayer doesn’t start losing the 199A deduction with $326,600 of business income. Rather, they can make $50,000 more than this amount and still take the full deduction.
The deduction, by the way, equals the lesser of 20% of the qualified business income or 20% of the taxable income taxed at ordinary tax rates. So, deductions that drive down the taxable income may effect the 199A deduction.
And while I’m on this subject, can I give you another example? Suppose some physician earns exactly $300,000 more than the threshold ($326,600 in 2020). So, $626,600.
If this taxpayer saves $50,000 into a pension, accumulates $50,000 in itemized deductions, and books $200,000 of losses from a spouse’s business or investments, the tax return shows $326,600 of taxable income and the return includes a generous 199A deduction. (The 199A deduction in this case probably equals 20% of the 326,600.)
Non-Medical-Services Income Separated and Tracked
The second way for a physician to get a 199A deduction? If the practice sells services or products that don’t actually count as medical services, possibly (probably?) the physician can treat that activity as a separate trade or business. And then, as long as she or he separates the books and financial records, that should mean a 199A deduction.
This gambit amounts to a bookkeeping strategy. And the specifics depend on the non-medical-services a physician provides. But teaching, research, writing all count as “non-medical” and so if separated into different trades or businesses and then separately accounted for, the business owner probably gets a 199A deduction.
And then in some cases other services and products should produce 199A deductions too. Some eye doctors probably sell glasses. Some physicians sell health related products. A number of physicians “blog.”
You see the recipe. Reorganize your activities into two trades or businesses, one that lacks eligibility because it’s an SSTB and one that doesn’t. Then, take the 199A deduction on the non-SSTB income.
By the way, this a second trade or business with “separable financial records and books” approach isn’t specific to physicians. So the bookkeeping and related rules described in another blog post apply: Final Section 199A Regulation: Separate vs. Separable.
Recategorizing the Income as Qualified Rather than Disqualified
And then possibly a third way exists for placing a Section 199A deduction onto a self-employed physician’s tax return. And this third way? It requires looking at what a physician actually does to determine whether tax law considers that work “medical services.” But this gets complicated, so we need to go into the weeds here.
Peek back at the 199A regulation I quoted earlier… You can see that the final regulations disqualify income a physician earns from “the provision of medical services.” Unfortunately, the regulations don’t define the term “medical services.” And this bit of sobering reality. The Internal Revenue Code doesn’t define the term “medical services” either.
But it turns out that the IRS has developed a definition of medical services which they use for other sections of the Code. And you might want to use the same definition for 199A.
Medical Services Defined
That definition? A “medical service” is something defined as an allowable medical care “itemized” deduction under code section 213(d).
In a nutshell, Section 213(d) provides that medical care consists of services for the diagnosis, cure, mitigation, treatment, or prevention of disease, including services for the purpose of affecting any structure or function of the body.
Not surprising, not everything “medical-y” creates a Section 213(d) medical deduction. Which means not everything “medical-y” counts as a medical service—at least for purposes of some parts of the tax law.
A first example… In applying Section 448’s rules of when someone provides medical services, the IRS says “look at Section 213(d).” (See Technical Advice Memorandum 9222004.) Note that Section 448 carries more weight than you might at first think when looking at Section 199A. The key bit of phrasing about what is a specified service trade or business comes from Section 448. Further, Congress approvingly references Section 448’s regulations when talking about how Section 199A should work in its committee report.
A second example… In determining when a physician’s salary rises to a level that triggers a Section 4960 excise tax because she or he isn’t providing medical services, the IRS again says, “look at Section 213(d).” (See IRS Notice 2019-09. ) Note that Section 4960 doesn’t connect closely to Section 199A. But it matters (maybe) that Congress added Section 4960 to the Internal Revenue Code at the same time as it added Section 199A. It would seem odd to use different definitions for a key term flowing out of the same legislation.
Cosmetic Surgery For Example…
Just to save casual readers from slogging through Section 213(d), here is the big example of this: Cosmetic surgery.
Specifically, here’s that blurb with the relevant bit of statute highlighted that says “hey cosmetic surgery and anything like cosmetic surgery? Yeah, they don’t count as medical deductions… sorry.”
The term “medical care” does not include cosmetic surgery or other similar procedures, unless the surgery or procedure is necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease.
(B)Cosmetic surgery defined.—
For purposes of this paragraph, the term “cosmetic surgery” means any procedure which is directed at improving the patient’s appearance and does not meaningfully promote the proper function of the body or prevent or treat illness or disease.
Therefore, a physician who provides cosmetic surgery or cosmetic procedures isn’t necessarily providing what tax law considers a “medical service.” That means the physician arguably gets the Section 199A deduction.
And there are other examples where the failure to achieve a Section 213(d) deduction creates or arguably creates a Section 199A deduction, too. Fertility treatments for same sex parents, for example. Surrogacy costs for some women.
Time to end this discussion. I’ve chattered on way too long.
But let me leave you with this thought. Most “business owning” physicians can get the Section 199A onto their tax returns. Many (most?) physicians report taxable incomes below the phase-out limits for example. And even those with higher incomes can push down their taxable incomes with deductions.
Surely a few physicians can do their bookkeeping in a way that creates books and financial records that separately report on qualified business income earned along side or inside a medical practice.
And then beyond that? Sure. A few physicians may be able to sidestep “specified service trade or business” status by using the IRS’s definitions of “medical services.”