Narrow definition of “Brokerage Services” for IRC §199A does not apply to IRC §1202
A recent IRS Chief Counsel Advice (CCA) reiterates that “brokerage service” is more narrowly defined for purposes of the IRC §199A qualified business income deduction than it is for purposes of the IRC §1202 exclusion of gain on the sale of qualified small business (QSB) stock. This is the case even though a specified service trade or business under IRC §199A is defined by reference to the QSB exclusion.
QBI deduction excludes SSTBs
The Section 199A deduction for qualified business income is an extraordinarily generous tax benefit. It allows owners to deduct up to 20% of their qualified business income (QBI) from sole proprietorships and pass-through entities like partnerships and S corporations.
However, for higher-income taxpayers, the deduction does not apply to income from a specified service trade or business. An SSTB is defined, in part, as a trade or business described in IRC §1202(e)(3)(A).
QSB gain exclusion also excludes brokerage services
IRC §1202 excludes gain on the sale of stock in a qualified small business (QSB). However, under IRC §1202(e)(3)(A), a trade or business that performs brokerage services cannot be a QSB.
Since a brokerage does not qualify for the §1202 gain exclusion (because it is excluded from the definition of a QSB), it might seem like it also should not qualify for the §199A deduction (because it is included in the definition of an SSTB). However, that is not necessarily the case.
QBI regs limit brokerage services to securities transactions
When the §199A deduction was enacted, the §1202 exclusions from QSBs were not well-developed. No cases had interpreted the exclusions, and the IRS had not issued regulations or relevant IRB items.
In contrast, the IRS issued detailed regs for the QBI deduction in 2019. These regs define a brokerage services business as one in which a person arranges transactions between a buyer and a seller, but only with respect to securities.
In explaining this limitation, the IRS admitted that “broker” may be used in a broad sense to include anyone who, for a fee, facilitates the sale and purchase of goods. However, the term “brokerage services” is more commonly associated with the facilitation of transactions involving stock and other securities.
However, in its recent CCA, the IRS concluded that this limited definition of “brokerage services” for purposes IRC §199A should not carry over to brokerage services for purposes of IRC §1202.
But limited definition does not apply to §1202 exclusion
The CCA concerned a company that operated a website similar to peer-to-peer rental companies like Airbnb. Lessees could use the website to find and reserve facilities that lessors listed in the company’s database. Lessors paid the company periodic fees to be included in the database.
The question was whether the company simply provided advertising services, or whether it provided brokerage services. The CCA concluded that the company provided brokerage services for purposes of IRC §1202, even though it did not provide brokerage services for purposes of §199A.
Different definitions explained by different statutory goals
The CCA explained the difference between the definitions of “brokerage services” by looking at the purposes of the different statutes. IRC §199A provides a deduction that is intended to effectively lower the tax rate for unincorporated businesses so it more closely matches the 21% flat tax rate for corporations. Thus, provisions that limit the deduction, like the SSTB rules, should be interpreted narrowly.
In contrast, IRC §1202 provides an exclusion from gross income, and exclusions are generally interpreted very narrowly so as to limit their scope. However, since the brokerage services rule is an exclusion from the exclusion, it must be interpreted as broadly as possible in order disqualify as much gain as possible from the exclusion.
Accordingly, a narrow definition of “brokerage services” furthers the policy goals of IRC §199A, while a broad definition furthers the policy goals of IRC §1202.
§199A limit for “brokerage services” seems to be here to stay
Given the statutory connection between §199A and §1202, some practitioners might have hoped that the narrow definition of “brokerage service” in the §199A regs would also apply to the §1202 exclusion. And given the lack of discussion of the limited definition when the IRS proposed and then adopted the regs, some practitioners might have worried that the “with respect to securities” language was a bit of a glitch that the IRS might later abandon.
However, the CCA suggests that the limited definition in the regs was very intentional. And it also makes clear that this definition, like the other §199A regs, applies only to §199A. Thus, it is likely that a much broader definition of “brokerage service” will continue to apply to §1202.
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