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Editorial 11 MIN READ

PLLC for licensed trades, a field report from the end of 2019

Twenty months after the TCJA revisit, the SSTB rules have hardened into final regulations and some professional firms have done the C-corp math

The Editors
Staff, Incorporator.org
11 min read Updated
Contents 7 sections
  1. What T.D. 9847 settled
  2. The 2019 thresholds, inflation-adjusted
  3. The C-corp conversion math, as firms are actually running it
  4. State law is still doing the hard shoving
  5. What a practice should actually be doing between now and the April 2020 filing
  6. The quiet part, one year on
  7. Sources

inal regulations under § 199A were signed in January and published in the Federal Register on February 8, 2019, as Treasury Decision 9847 at 84 FR 2952. Twenty months after we wrote that a PLLC for a licensed trade now sat on the wrong side of the pass-through deduction, the rulebook it sits against is fully drafted and the first year of returns is in the file cabinet.

This is a field report from the end of 2019. Our August 2016 piece on the PLLC for licensed trades explained the form the states force on doctors and lawyers. The April 2018 revisit explained what the Tax Cuts and Jobs Act did to the federal side. This piece reports what the final regs say, what the early planning responses look like, and how the C-corp conversion math actually runs when a professional firm sits down and does it.

What T.D. 9847 settled

The proposed regulations published August 2018 left the licensed trades two open questions. First, how wide is the "reputation or skill" catch-all in § 199A(d)(2)(B), which by its own terms sweeps in "any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners"? Second, how does the rule treat a practice that earns some revenue from a non-SSTB activity (product sales, a separate facility fee, a diagnostic lab) alongside its SSTB core?

On the first question, the final regulations narrowed the catch-all substantially. 26 CFR § 1.199A-5(b)(2)(xiv), as promulgated by T.D. 9847, limits the "reputation or skill" clause to three discrete situations: endorsement income, licensing an individual's name or likeness, and appearance fees. The practical effect is that a doctor is an SSTB because medicine is listed in § 199A(d)(2)(A), not because of anything to do with reputation or skill. The catch-all will not pull a surgical device company into SSTB status merely because a surgeon owns it.

On the second question, the final regs carried forward the de minimis rule from the proposed regs, with small edits. For a trade or business with gross receipts of $25 million or less, the whole enterprise escapes SSTB status so long as less than 10% of gross receipts come from SSTB activity. Above $25 million in gross receipts, the threshold drops to 5%. The rule is 26 CFR § 1.199A-5(c)(1). For a typical physician practice, the ratio runs the other way: SSTB medicine is the dominant revenue and any ancillary non-SSTB activity is a rounding error, which means the whole practice is an SSTB and the 20% deduction phases out on all of it above threshold.

The final regs also finished the rule on the "crack and pack" tactic that proposed regs had flagged. An SSTB owner cannot spin ancillary functions (billing, management, real estate) into a sister entity owned by the same people in the hope that the sister entity's income qualifies for the deduction. Under 26 CFR § 1.199A-5(c)(2), a trade or business that provides 80% or more of its property or services to an SSTB, and that has 50% or more common ownership with the SSTB, is itself treated as an SSTB to the extent of that shared ownership. A law firm cannot rent its office from a real estate LLC owned by the same partners and then claim the real estate LLC's rent income is non-SSTB. The anti-abuse rule reaches it.

The 2019 thresholds, inflation-adjusted

The § 199A threshold figures we wrote about in April 2018 were the statutory 2018 numbers. The 2019 amounts, set by Rev. Proc. 2018-57, are $160,700 of taxable income for single filers and $321,400 for married filing jointly, with a $160,725 threshold for married filing separately. The phase-in range above those numbers is the same $50,000 and $100,000 the statute specifies, so a single-filer SSTB owner is fully phased out above $210,700 of taxable income, and a joint-filer SSTB is fully phased out above $421,400. Inflation is doing modest work at the margin, but the shape of the compound we described last April has not moved. A two-partner law firm, two spouses working, is still well over the ceiling and still loses the deduction on the law firm income.

For an individual doctor or lawyer whose household taxable income sits inside the phase-in range, the deduction partially survives, prorated on a sliding scale under § 199A(b)(3)(B) and fleshed out in 26 CFR § 1.199A-1(d)(2)(iii). Threshold management, which we flagged in April 2018 as speculative planning, is now routine. A retirement plan contribution, a defined-benefit plan for a spouse-employee, a 529 gift out of the household's deferred compensation, and a year-end charitable gift are the ordinary levers. For a married pair of surgeons with aggregate taxable income of $500,000, dropping below $421,400 is not realistic. For a single-shingle lawyer grossing $350,000, it often is.

The C-corp conversion math, as firms are actually running it

We wrote in April 2018 that the § 11(b) rewrite, which killed the 35% flat rate for personal service corporations and replaced it with the ordinary 21% C-corp rate, helped only professional practices that had a genuine reason to retain capital. Eighteen months in, some firms have done the integrated-rate math on paper and a smaller number have actually converted. The population that converts is narrower than the headline 21% rate suggests.

Run the numbers on a two-partner PC distributing all its earnings every year. The firm earns $1,000,000 of pre-tax profit. Under the pass-through stack, with no § 199A because it is an SSTB and the partners are well above the joint threshold, each $500,000 share flows to the partner's personal return and is taxed at ordinary rates topping out at 37% under § 1, plus state income tax, plus 3.8% net investment income tax on the portion that is investment-like and 2.9% self-employment Medicare on the portion that is earned. Round federal to 37% on the marginal slice and the integrated rate on distributed pass-through income is approximately 37% plus state.

Run the same million through a C-corp. The corporation pays 21% at the entity level under § 11(b), leaving $790,000. Distribute that $790,000 as a qualified dividend and the shareholder pays 20% under § 1(h) plus 3.8% NIIT under § 1411, for a 23.8% individual-level rate, leaving $602,020. The integrated federal rate on a distributed C-corp dollar is therefore 1 - (0.79 × 0.762) = 39.8%, which is worse than the 37% pass-through rate, not better. The 21% entity rate is a teaser; the second layer erases the saving.

C-corp math starts working only when the dollar does not come out. Retain the $790,000 inside the corporation, reinvest it in equipment, buildout, a second location, accounts receivable growth, or retained cash for a planned acquisition, and the second layer is deferred indefinitely. Now the comparison is 21% corporate versus 37% pass- through, and the C-corp is sixteen points cheaper on the retained portion. The firms converting in 2019 are disproportionately the ones with a real capital plan: multi-location dental service organizations, surgical specialty groups buying out senior partners with retained earnings, and a handful of large regional CPA firms that have been reinvesting in technology and are happy to park earnings inside the entity.

The firms that looked at conversion and stayed pass-through are the ones whose partners take out substantially everything they earn every year. A four-partner litigation boutique with no capital needs has no reason to sit a retained dollar inside a C-corp it will eventually distribute; the integrated rate lands in the high thirties either way and the C-corp form adds payroll, basis tracking, and the reasonable- compensation debate with an IRS examiner who is now looking at a former PC. Conversion is a strategy for practices that have reinvestment outlets. It is not a federal tax break for professionals broadly.

State law is still doing the hard shoving

The federal side has moved twice in eighteen months. The state side has not moved at all. California Corporations Code § 17701.04(e) still prohibits LLCs of any kind from rendering professional services defined by § 13401, which means a California physician or lawyer still forms a professional corporation under the Moscone-Knox Act at §§ 13400-13410, pays California's 8.84% corporate franchise tax under R&TC § 23151 on corporate income, and pulls a salary that is ordinary income again on the shareholder return. The Sacramento bill file for the 2019-2020 session does not contain a PLLC authorization.

New York's Limited Liability Company Law § 1203, which we cited in April 2018, still requires members of a PLLC in medicine, dentistry, veterinary medicine, engineering, architecture, land surveying, or landscape architecture to be individually licensed in the profession the PLLC renders, and still routes attorneys, physicians, and most licensed health-adjacent professions into either a PLLC or a professional service corporation under BCL § 1503. The New York Department of State will not file a regular domestic LLC for an enterprise whose articles describe a practice of medicine.

Illinois, which adopted its Professional Limited Liability Company Act at 805 ILCS 185/ in 2003 and amended it repeatedly since, sits in the familiar middle: PLLC is available, professional service corporation is available, and the choice between them is a federal tax question now rather than a state law one. Section 10 of the Illinois PLLC Act requires a certificate of registration from the Department of Financial and Professional Regulation before the Secretary of State will accept the filing; § 25 preserves the personal liability of any manager, member, or employee for that person's own professional misconduct, which is the standard professional-entity shield: the entity protects co-owners from each other's malpractice, not the practitioner from the practitioner's own.

That shield is the piece that matters in the failure-mode conversation. A professional entity (PLLC or PC, it does not matter) shields a partner's personal assets from a judgment against another partner arising out of that other partner's professional acts. It does not shield the malpracticing partner from the plaintiff, because no state permits a licensed professional to escape personal liability for the professional's own acts of negligence. The rules are plain on the face of every PLLC statute we cite. The shield is meaningful, but narrower than founders often assume at formation.

What a practice should actually be doing between now and the April 2020 filing

Below threshold, ignore all of this and take the 20% on the full qualified business income. The threshold rule is in § 199A(e)(2) and the 2019 dollars are $160,700 single and $321,400 joint per Rev. Proc. 2018-57.

In the phase-in range, compute the partial deduction under 26 CFR § 1.199A-1(d)(2)(iii) and then decide whether threshold management (retirement plan, deferred comp, charitable gift, income timing) lands the household below the top of the phase-in. A year-end calculation that drops a household from $400,000 of taxable income to $319,000 preserves the full SSTB deduction for that year, and the numbers are usually worth the planning fee.

Above the phase-in ceiling, § 199A is gone for SSTB income and the question is whether the practice has a capital plan that makes a C-corp conversion integrated-rate-positive. A two-surgeon practice planning a $3 million ambulatory surgery center buildout has that plan. A five-lawyer firm taking draws to the last dollar each quarter does not.

Entity conversions in the middle of a tax year are awkward; the F reorganization under Rev. Rul. 2008-18 is the cleanest path for a state-form change that preserves the EIN and the existing client engagement letters, and conversions of PLLCs to PCs or PCs to PLLCs under state-law conversion statutes (where they exist) are a separate question that belongs with state-law counsel. Neither is work to do between Thanksgiving and January 1 of a filing year.

The quiet part, one year on

The § 199A design we flagged in April 2018 as a parity fix that excluded most of the professions forced into a professional entity has played out exactly that way in the 2018 returns. The doctors and lawyers and CPAs did not get the 20%, the engineers and architects did, and the 21% C-corp rate helped only those professional firms with real capital plans. What the final regs settled is the edge: the reputation-or-skill catch-all turned out to be narrow rather than expansive, the crack-and-pack workaround turned out to be closed, and the de minimis rule sat roughly where the proposed regs placed it. Treasury did not rewrite the SSTB list because Treasury does not have that power. Congress drew the list. Congress kept it.

Sources

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