The SSTB “Gauntlet” Tax Zone

Do you own a successful Specified Service Trade or Business? You may be poised to enter the “SSTB Gauntlet” tax zone.

Definition of a Specified Service Trade or Business: A specified service business is a trade or business to which any of the following applies [IRC Sec. 199A(d)(2)]:
A. It involves the performance of services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, or brokerage services.
B. Its principal asset is the reputation or skill of one of its owners or employees.
C. It involves investing and investment management, trading, or dealing in securities, partnership interests, or commodities.

The Qualified Business Income Deduction (QBI) was part of the Tax Cuts and Jobs Act of 2017. It generally provides a 20% deduction on business income from pass-through entities, Schedule C businesses, and rental property income, all subject to additional rules which are beyond the scope of this short article.

For Specified Service Trades or Businesses, income is limited in the amount of the deduction if the individual’s taxable income is above a certain dollar amount. In 2021 for example, the deduction was phased out from 20% to 0% for married individuals with taxable income (before QBI deduction) over $329,800 to $429,800.

Coincidentally in 2021, the marginal tax rate 24% to 32% at $329,850 in taxable income (after QBI deduction). Income at $329,800 is taxed at 24%.

This creates a confluence of an 8% marginal tax increase (24% vs 32%) and the loss of an approximately $60,000 QBI tax deduction from an increase in income of only $100,000. Keep in mind that this is not a tax rate per se, it is a dynamic created by a confluence of rules.

There are as many outcomes as there are scenarios in this area. However, there are clear examples of the incremental federal tax rate within this zone of approximately 50%. The incremental rate normalizes back to the tax rates on federal tax tables (likely 35%) after this zone. That’s not great relief however as this zone (and its incremental tax rate) remains in place, even if your business has grown to even higher income levels where the incremental tax rate decreases.

If you own an SSTB-categorized business and your total taxable income is approaching $300,000, you should discuss with your tax professional planning and mitigation actions during the year that you may take to lessen the impact.