Why again does it matter if your business is defined as a SSTB? Income generated by an SSTB has stricter rules for calculating the 20% pass-through deduction.

Demystifying the Specified Service Trade Business


Jeremy Smith, CPA

The pass-through deduction, otherwise known as the qualified business income deduction (QBI), has been a powerful tool for small business. The Tax Cuts and Jobs Act of 2017 allows pass-through and small business owners a 20% deduction of qualified business income, not including income from portfolio-type investments, guaranteed payments to partners, foreign income or W-2 wages. The deduction can be taken by individuals in a sole proprietorship, partnership, S corporation or trust and estate. It looks simple, but with all things IRS related, the QBI deduction and the Specified Service Trade Business designation isn’t as cut and dry as it seems.

First, we need a crash course in QBI. The QBI deduction is taken by individuals, not companies, and it’s subject to phaseouts. For taxpayers with taxable 2020 income under $326,600 for married filing jointly or $163,300 for single filers, the QBI deduction is calculated as the lesser of 20% of QBI or 20% of taxable income. In 2021 those limits will rise to $164,900 for single filers and $329,800 for joint filers.

For taxpayers whose taxable income is above $326,600 for those filing jointly or $163,300 for single filers, the QBI deduction is subject to additional limitations. The deduction is the lesser of:

  • 20% of QBI, or
  • the greater of
    • 50% of W-2 wages paid, or
    • 25% of W-2 wages paid (directly as a sole proprietor or as noted on your schedule K-1) plus 2.5% of the unadjusted basis of newly acquired qualified property.

Once you hit total taxable income of $213,300 for single or $426,600 married filing jointly the deduction disappears.

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This is the part that gets hairy. The IRS added hurdles to the deduction for businesses they consider specified service trades or businesses (SSTB). Let’s start by telling you what is NOT a “qualified trade or business”.  A “qualified trade or business” is any trade or business, with three exceptions:

  • A trade or business conducted by a C corporation
  • The trade or business of performing services as an employee (W-2 wages)
  • An SSTB with taxable income that exceeds the above threshold amounts
    • A single taxpayer with multiple sources of income is considered an SSTB if gross receipts from the business are $25 million or less for the year and 10% (5% if gross receipts are > $25 million) or more of those gross receipts are derived from SSTB business activity.

So, what is an SSTB business activity?

  • Medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists and other similar health care professionals interacting directly with patients.
  • Legal services provided by lawyers, paralegals, arbitrators, mediators and other legal professionals.
  • Accounting services by accountants, enrolled agents return preparers, financial auditors and other accounting professionals.
  • Actuarial science services performed by actuaries and similar professionals.
  • Performing arts professionals such as actors, singers, musicians, entertainers, directors and similar professionals.
  • Consulting services providing advice and counsel to clients to assist the client, including providing advice and counsel regarding advocacy with the intention of influencing decisions made by a government or governmental agency and all attempts to influence legislators and other government officials on behalf of a client by lobbyists and other similar professionals performing services in their capacity as such.
  • Athletes, coaches and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards and racing.
  • Financial services including managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings and raising financial capital by underwriting, or acting as a client’s agent in the issuance of securities and similar services. This includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals performing services in their capacity as such.
  • Brokerage services in which a person arranges transactions between a buyer and a seller with respect to securities for a commission or fee. This includes services provided by stockbrokers and other similar professionals but does not include services provided by real estate agents and brokers or insurance agents and brokers.
  • Investing and investment management by providing investing, asset management or investment management services for a fee, including providing advice with respect to buying and selling investments.
  • Trading securities, commodities or partnership interests. Whether a person is a trader in securities, commodities or partnership interests is determined by the source and type of profit that is associated with engaging in the activity regardless of whether that person trades for the person’s own account, for the account of others or any combination thereof.
  • Dealing in securities, partnership interests or commodities by regularly purchasing securities from and selling securities to customers or regularly offering to enter into, assume, offset, assign or otherwise terminate positions in securities with customers.

Side note: Oddly, engineers and architects are explicitly excluded from being defined as a specified service.

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Along with the above criteria, your income is also considered SSTB if it’s derived from performing services as an employee who then becomes an independent contractor providing the same service they provided as an employee, and a W-2 employee who is promoted to a K-1 partner but continues to provide the same service they provided as a W-2 employee.

While the IRS has provided the above list of services that fall under the SSTB heading, some businesses are still relegated to gray space. Enter the reputation and skill test.

Under the reputation and skills test, a business is only considered a Specified Service Trade Business if it generates fees, compensation or other income by:

  • Endorsements of products or services
  • Use of an individual’s image, likeness, name, signature, voice, trademark or any other symbol associated with the individual’s identity
  • Appearances on radio, television or other media

So, after reading all of this, why again does it matter if your business is defined as a Specified Service Trade Business? Income generated by an SSTB has stricter rules for calculating the 20% pass-through deduction.

There’s a reason blog postings on this topic continue to be some of our most popular postings year after year. We know this is a big hairy mess. But we’re here to help. If you have any questions on whether or not you qualify as an SSTB or how much of the QBI deduction you’re eligible for, don’t hesitate to reach out to us.


Jeremy Smith, CPA, Partner, specializes in consulting, tax planning and compliance work for both individuals and closely held businesses. He can be reached at (480) 839-4900 or JeremyS@hhcpa.com.