October 2, 2018

Tax Reform and Your Business: Long-Term Care Facilities (article)

Man holds building blocks that spell reform.

The long-term care industry did not get the news it wanted on August 8 when the IRS released new proposed regulations on the Qualified Business Income (QBI) deduction. The 20 percent QBI deduction was created by the 2017 tax reform law, and is very important to a long-term care industry that is approximately 70 percent privately owned. Unfortunately, many businesses that provide both assisted living and skilled nursing services may not be eligible for the QBI deduction.

A Closer Look at the Proposed Regulations

The issue is whether a long-term care business is performing services in the field of health, which is a specified service trade or business (SSTB). If a long-term care business that provides assisted living and skilled nursing services is an SSTB, then its owners would be ineligible for the deduction when their income rises above a certain threshold. The proposed regulations do not address assisted living facilities or skilled nursing facilities, even though they appear to be one of the closest calls in this area.

The proposed regulations define performance of services in the field of health as “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 who provide medical services directly to a patient (service recipient).” On the other hand, the proposed regulations provide that certain services are not in the field of health even though they may purportedly relate to the health of the service recipient. The regulations provide examples, such as the operation of health clubs or health spas, or the research or manufacture of pharmaceuticals as services that are not in the field of health.

For an owner of an assisted living facility, there is a strong argument that such a facility is not primarily engaged in the field of health because such a facility provides many other services. These services include assistance with daily living activities, dining services, educational activities, transportation services, and exercise programs, all of which lie outside the field of health.

For many assisted living facilities, skilled nursing or other health services may comprise a very small portion of their business. For instance, contrast an assisted living facility with a skilled nursing facility, which under a non-tax section of federal law is defined as an institution engaged in “(A) skilled nursing care and related services for residents who require medical or nursing care, or (B) rehabilitation services for the rehabilitation of injured, disabled, or sick persons . . .” Many assisted living facilities bear little resemblance to such a skilled nursing facility. And even for institutions that are skilled nursing facilities under this definition, their activities conducted involve more than health services, and include a substantial amount of personal living accommodations (residency, meal preparation, laundry, etc.). But for both assisted living and skilled nursing facilities, each provide at least some services that are clearly within the field of health, which distinguishes them from the “health club or spa” that is sanctioned in the proposed regulations for the QBI deduction.

With this mix of services provided by an assisted living facility, the issue at hand is whether a small portion of health services is enough to render the facility entirely in the field of health. The proposed regulations provide a de minimis rule for any industry with a small amount of gross receipts from an SSTB. Under the de minimis rule, a single trade or business (TOB) will not be an SSTB when less than a specified percentage of gross receipts of the TOB is attributable to the performance of services in an SSTB category. For a TOB with overall gross receipts of $25 million or less, services in an SSTB category are ignored to the extent they do not exceed 10 percent of total gross receipts; for all other TOBs the relevant threshold is 5 percent.

This is a strict threshold that, if exceeded, recasts the entire business as an SSTB. Thus, an assisted living facility with $10 million of revenue and where $1,000,001 of that revenue is from services in the field of health would be classified completely as an SSTB (i.e., $8,999,999 of the non-health services revenue would be tainted as SSTB revenue). The business owners would likely be ineligible for the QBI deduction based on their level of taxable income in this scenario.

It could be argued that this rigid threshold runs contrary to the intent of the law in that it potentially denies a facility owner the entire deduction when a business overwhelmingly engages in something other than a specified service. This is an issue that is not unique to long-term care facilities, but is one that weighs heavily upon them due to their typical ownership structures.

Next Steps

The proposed regulations could be changed prior to being finalized, and could be challenged otherwise – a process that could take years to resolve. An IRS spokesman recently opined that any changes to the proposed regulations in this area would not be any less harsh, as that would require a new set of proposed regulations and the procedures required therefor. As a result, owners of long-term care facilities and their tax advisors should carefully consider the percentage of services in the field of health provided. Further, there may be additional steps that the facility could take to insulate the non-health services provided by the facility from its health services, in order to potentially preserve the QBI deduction for the non-health services business.

For more information on these steps and about the overall impact of the new tax law on assisted living facilities, please contact your local CBIZ and MHM tax professional.

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