Tax Reform and Your Business: Athletes and Performing Artists (article)
Performance distinguishes athletes and entertainers, and talented performances in sports and the performing arts are big business, with billions in revenue generated each year. This revenue attracts investment and innovation in sports and entertainment activities across the country. The athletes and entertainers may have multiple other talents supporting them or bringing their performances to the public. For example, there are specialized trainers, coaches, and data analysts for athletes. For performing artists, support may come from costume designers, instructors, engineers, and promoters. These support activities will generally benefit from the new Tax Cuts and Jobs Act (TCJA), either from lower corporate tax rates or from the new 20 percent deduction for Qualified Business Income (QBI). Without proper tax planning however, the athletes and entertainers who are the focus of the crowd's attention will not see many of the benefits from the TCJA.
Athletes are generally employees of teams for which they play, but even in cases where they are solo (such as professional golfers and tennis players) the TCJA's QBI deduction is not available to them. The same is true for performing artists. Athletes and performing artists are included in a category of specified services trades or businesses (SSTB) that are ineligible for the QBI deduction.
For the time being (until regulations are published), it appears "performing arts" means the provision of services by actors, actresses, singers, musicians, entertainers, and similar artists in their capacity as such. Likewise, it appears this term does not include the provision of services by persons who themselves are not performing artists. Such other persons may be those who manage or promote artists, other persons in a business that relates to the performing arts, or persons who broadcast or otherwise disseminate the performances of artists to members of the public. Also, it appears that performing arts refers to arts such as drama, dance, and music that involve performance before an audience, where other performance that is not made before an audience (motion picture directing) would not be considered performing arts. This suggests that other artists, such as authors, photographers, and painters would not be performing artists and would therefore be eligible for the QBI deduction.
Because athletes and performing artists are included within the SSTB designation, they cannot claim the 20 percent QBI deduction on income generated from their services. Furthermore, income generated from the use of their likeness (i.e., income from advertising or promotional activity) is not eligible for the QBI deduction either. This is because an SSTB also includes 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 or owners.
For marketable athletes and performing artists, these restrictions appear to be a major roadblock on the road to claiming one of the TCJA's biggest benefits. However, it may be possible to plan an alternate route that captures most of the potential QBI deduction. A marketable athlete or entertainer (and any other person whose business is classified as an SSTB) can examine his or her business activity and look for opportunities to separate the "good income" (income from activities that are not SSTBs) from "bad income" (income from an SSTB). For performing artists this could be achieved by forming a separate entity for the production aspect of their business.
In the music industry, an artist who produces his or her own shows could house the stage crew, sound engineers, and other staff necessary to produce a concert tour in a separate pass-through entity (PTE). Income received by this PTE's production business would be eligible for the deduction. This again depends on the scope of "performing arts" for QBI deduction purposes (see the previous discussion), which appears to exclude the provision of services by persons who themselves are not performing artists (e.g., persons who may manage or promote such artists, and other persons in a trade or business that relates to the performing arts). Thus, by separating the income from the production crew from the income of the artist, it appears that the production income will be eligible for the QBI deduction.
This concept may also extend to a method for extending the QBI deduction to income generated from marketing or promotional activities, such as advertisements. In this scenario, the athlete or performing artist would assign to another PTE (owned by the individual) a license to use the individual's image or likeness. Such an assignment would make the asset belong to the other PTE (and not to the owner or other employees), the income from which seemingly should qualify for the QBI deduction. Whether this approach would pass scrutiny from the IRS is a question to be answered by forthcoming regulations. As mentioned previously, income derived from the reputation or skill of one or more of an entity’s employees or owners is included as income from an SSTB, and is ineligible for the QBI deduction. To overcome a challenge by the IRS on this point, the athlete or performing artist must successfully argue that the asset does not relate to the reputation or skill of the individual, but rather to the license itself.
Separating out non-SSTB activities from a single enterprise could have ancillary benefits beyond the QBI deduction, such as reducing liability risks and tracking the profitability of those ancillary activities. It is also noteworthy that many PTEs that are related to athletics or the performing arts will likely be entitled to the QBI deduction, without having to overcome the hurdles that the athletes and performing artists face. As noted previously, the SSTB designation appears to only apply to the athlete or artist for income generated from their performance. Thus, a sports training facility or a for-profit music school would not be classified as SSTBs under this interpretation, even though they are clearly related to athletics and the performing arts. However, there are exceptions. A facility such as a gymnastics training center may have to count the skill or reputation of one of its coaches as its principal asset, particularly if that coach is also an owner. It could also apply to an individual providing music lessons as a sole proprietor. The issue when skill or reputation is the principal asset of a business is unresolved, and without further guidance from the IRS it will likely remain that way for a substantial period of time.
The TCJA, and the QBI deduction in particular, was not designed to provide a major tax break to those who provide specialized services such as athletes and performing artists. Nonetheless, with creative planning, athletes and performing artists may be able to receive at least a portion of the benefit afforded by the QBI deduction. Additionally, the new tax law may benefit PTEs that are not SSTBs but which provide services to athletes and performing artists. As can be seen, these distinctions are highly nuanced and require careful analysis. For more information on the QBI deduction and how your business can best take advantage of the changes within the TCJA, please contact your CBIZ MHM tax professional.
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