199A Deductions for Laboratory Facilities: Defining the Field of Health Using Section 448’s Function Test

The Tax Cuts and Jobs Act of 2017 created a new provision, Internal Revenue Code Section 199A which permits owners of sole proprietorships, partnerships, or S corporations to deduct up to twenty percent of the income earned by the business.[1]  However, the 199A deduction does not apply to business income earned by owners of a specified services trade or business (“SSTB”). Relevant to this discussion, a SSTB includes any trade or business involving the performance of services in the fields of health.[2]  The treasury regulations, although detailed, do not clarify whether certain ancillary services—specifically laboratory services—are included within the field of health.   Because the provisions are similar, using IRC Section 448, some ancillary services,[3] namely those provided by laboratory facilities, are not SSTBs within the field of health. 

Section 199A & “Field of Health” SSTBs

Section 199A defines SSTBs and generally excludes them from the definition of a qualified trade or business.  Section 199A disqualifies SSTBs to prevent business owners from converting personal service income into qualified business income and deducting twenty percent of that income.[4]  Treasury Regulation 1.199A-5(b) clarifies what constitutes a SSTB in the field of health. The regulation includes “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” in the definition of a SSTB.[5]  

Currently, there is little guidance clarifying which activities disqualify a taxpayer’s trade or business income as a SSTB, especially for SSTBs in the field of health.  Often, other provisions within the Code can clarify the intended meaning of a statute or its application.  The Treasury Department has issued temporary regulations concerning I.R.C. Section 448 defining personal service corporations in the field of health.  Thus, Section 199A’s regulations defining the field of health can be interpreted similarly to Section 448’s regulations because their language defining the field of health is similar.  Case law and private letter rulings defining the field of health under Section 448 can be used to create the same result for certain ancillary services under 199A. 

Section 448 Defining “Field of Health”

The case law and private letter rulings demonstrate a two-part analysis of a taxpayer’s business under Section 448 to determine if a personal service corporation is in the field of health: the function test and the ownership test.  The function test looks to the following three elements: (1) whether the services were medical services; (2) whether the medical services were provided by a healthcare professional; and (3) whether those medical services accounted for substantially all of the taxpayer’s activities.[6]  The ownership test focuses on the ownership of the corporation’s stock.[7]  When using Section 448 as guidance to define the field of health under Section 199A, the analysis should focus on the function test because its elements speak to whether the personal service corporation is within the field of health.

Some ancillary services have been identified as within the Section 448 interpretation of the field of health.  The ancillary services that have been addressed under Section 448—radiology,[8] emergency medical ambulance services,[9] and ultrasound services[10]—are similar in that the medical services they offer involve direct contact with the patient.  The radiology technicians, emergency medical technicians, and sonographers all engage in patient contact and diagnose or treat the patient based upon their skill.  The medical services provided to patients by all these healthcare professionals—including nurses and physicians—involve direct patient contact, diagnosis, and treatment of patient symptoms and medical issues.  The technicians providing these medical services under Section 448 are analogous to the healthcare professionals listed in the Section 199A regulations, both in the degree of schooling and certifications required.  It is less clear, however, how other ancillary services—namely laboratory facilities—would compare to those services that the IRS and the Tax Court have clearly designated as engaged in the field of health.

Laboratory Facilities Fail the Function Test

Laboratory facilities, especially those that solely process the specimen samples collected from other medical facilities, fail the first element of the function test because they do not provide the same medical services as radiologists, emergency medical technicians, and sonographers.  Instead, some phlebotomists will have direct contact with the patient briefly to draw the necessary sample.  Then, other technicians use the facility’s technology to process the sample and generate a report that is sent to the medical provider who ordered the labs.  That provider then interprets the report and diagnoses the patient.  Laboratory services do not involve extensive direct patient contact or diagnosis and treatment of patient symptoms and medical issues; therefore, laboratory services should not be considered medical services under the function test.  The services provided by these laboratory facilities fail the first element of the function test because they are not similar enough to the other medical services provided.

Laboratory technicians and phlebotomists are not healthcare professionals because those technicians do not need the same level of schooling or credentials as the listed providers.  Therefore, they are not healthcare providers and fail the second element of the function test.  The two primary employees of laboratory facilities are lab technicians and phlebotomists.  While these professionals must be certified,[11] the education requirements are much lower than physicians, [12] nurses,[13] dentists,[14] or other medical professionals listed in Regulation 1.199A-5(b).  Laboratory facilities do not provide medical services under the first element of the function test, and laboratory technicians and phlebotomists are not healthcare providers under the second element of the test.  Because laboratory facilities fail both elements of the function test under Section 448, they should be excluded from the field of health under Section 199A and not be treated as a SSTB.

Potential Issues Using Section 448 as Guidance on the Field of Health

There are some problems with using the Section 448 Regulations and their interpretation to define the field of health under Section 199A.  Primarily, Section 448’s requirement that substantially all, 95 percent, of the taxpayer corporation’s activities are devoted to medical services by healthcare professionals differs from the language in Section 199A.  Section 199A has no substantiality requirement to limit which trades or businesses are considered a SSTB.  Analyzing whether certain ancillary services are SSTBs in the field of health solely by looking to Section 448 suggests that even a small number of services provided in the field of health could taint the income and disqualify it from the 199A deduction. 

This difference between Section 199A and Section 448 could support the argument that these provisions and their respective “fields of health” should not be interpreted to be equally as broad.  Since other requirements under Section 448 limit its applicability, specifically the substantiality requirement, Section 199A should be interpreted more narrowly—limiting the kinds of businesses included in the field of health—because it does have a similar substantiality limitation. 

This argument fails however because of the process by which the field of health is analyzed under Section 448.  The case law and private letter rulings demonstrated a two-part analysis of a taxpayer’s business under Section 448: the function test and the ownership test.  The function test, and its three elements, were the primary focus of the courts and IRS’s analysis when defining the field of health.  These three elements included (1) whether the services were medical services; (2) whether the medical services were provided by a healthcare professional; and (3) whether those medical services accounted for substantially all of the taxpayer’s activities.  Because the language in the Section 199A and Section 448 regulations are the same in that respect, the interpretation of the first two elements of the function test can be used as persuasive authority on whether laboratory services are medical services provided by healthcare professionals.

Additionally, a taxpayer whose business provides a small number of services in the field of health relative to its other qualified business could spin off the activities of a potentially qualifying business into a separate entity so that income would still qualify for the 199A deduction.  However, this option would likely fail under Section 199A’s anti-abuse rule if the trade or business provides property or services to a SSTB and the two trades or businesses share 50 percent or more common ownership.[15]  

Conclusion

Section 199A is a relatively new addition to the Code, and there is little to no authority interpreting its statutory provisions and regulations which creates ambiguity as to which ancillary services are SSTBs and excluded from the 199A deduction because they operate within the field of health. Some ancillary services—namely those provided by laboratory facilities—should be considered outside the field of health and therefore not SSTBs because they do not satisfy the function test under Section 448.  Assuming all other requirements of Section 199A are met, the owners of these ancillary service businesses should be able to deduct twenty percent of their qualified business income from these businesses.

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[1]  Tony Nitti, Understanding the new sec. 199A business income deduction, Tax Adviser (Feb. 1, 2018), https://www.thetaxadviser.com/issues/2018/apr/understanding-sec-199A-business-income-deduction.html [https://perma.cc/37QQ-D23D].

[2] I.R.C. § 199A(d)(2).  The other fields are law, engineering, architecture, accounting, or any business whose principal asset is the reputation or skill of one or more of its employees. Id.

[3]  For the purposes of this analysis, ancillary services are “medical services or supplies that are not provided by acute care hospitals, doctors, or health care professionals.”  What are Ancillary Services?, Horizon Blue, https://www.horizonblue.com/sgs/tools-services/find-doctor/what-are-ancillary-services [https://perma.cc/G6HR-ZWZ9].

[4]  Nitti, supra note 1.

[5]  Treas. Reg. § 1.199A-5(b).

[6]  1992 PLR LEXIS 2543, at *7, 9 (I.R.S. Nov. 23, 1992).

[7]  Treas. Reg. § 1.448-1T(e)(5)(i).

[8]  See W.W. Eure, M.D., Inc. v. Comm’r, No. 12224-05, 2007 Tax Ct. Memo LEXIS 125 (T.C. May 17, 2007).

[9] See 1992 PLR LEXIS 2543, at *9 (I.R.S. Nov. 23, 1992).  But see Chickasaw Ambulance Serv. v. United States, 1999 U.S. Dist. LEXIS 24373, No. C97-2094 (N.D. Iowa May 21, 1999).

[10] See Zia-Ahmadi v. Comm’r, Nos. 23635-13S, 23636-13S, 2017 Tax Ct. Summary LEXIS 39 (T.C. June 14, 2017).

[11]  See How to Become a Medical Laboratory Technician, Nw Health Sciences Univ., https://www.nwhealth.edu/blog/how-to-become-a-medical-laboratory-technician/[https://perma.cc/T2HD-GYEX]; Phlebotomy Degrees, Colleges & Degrees, https://www.collegesanddegrees.com/programs/phlebotomy [https://perma.cc/7UP4-DN8C].

[12]  The training required for physicians lasts anywhere between seven and fifteen years.  See, The Road to Becoming as Doctor, Association of American Medical Colleges (Nov. 2020), https://www.aamc.org/system/files/2020-11/aamc-road-to-becoming-doctor-2020.pdf [https://perma.cc/3M67-Z62J].

[13]  To become a registered nurse, a person must complete a nursing program and take the NCLEX-RN, a certification exam.  How to Become a Registered Nurse, Nurse J. (Feb. 25, 2022), https://nursejournal.org/registered-nursing/how-to-become-a-rn/ [https://perma.cc/SUA6-XE8U].

[14]  To graduate and become a dentist, students must complete three to four years of undergraduate education plus four years of dental school.  Exploring a Dental Career:What education requirements must dentists meet?, Am. Dental Ass’n, https://www.ada.org/resources/careers/practicing-dentistry [https://perma.cc/DBE7-XKB2].  State licensing boards determine the certification requirements.  Id.

[15]  Treas Reg. § 1.199A-5(c)(2)(i).