Service vs Non-Service Business and Why You Should Care

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One of the unusual definitions under the new Tax Cuts & Jobs Act for the pass-through tax reduction is whether your business is a service or a non-service business.

This is not the same definition we’ve used in the past for Professional Service Corporations (PSC), as part of the C Corporation definitions. This is a big change that CPAs and tax attorneys are realizing. The problem is that the PSC is a clearly defined term, with IRS Code and case law to back it up. We have strategies to avoid PSC, whenever possible.

But now, there is a brand new term and definition and it’s not quite as clear.

First of all, let’s look at why you should care. If you have a pass-through business entity, such as an S Corporation, partnership, LLC taxed as an S Corporation or partnership or Schedule C (Sole Proprietorship), you may have a new tax break effective in 2018. The pass-through income may be subject to a 20% reduction.

But, the laws are applied differently depending on whether you are a service business or a non-service business. In this case, it’s better to be a non-service business.

A service business is a business in which you and your employees work primarily providing services. A non-service business is one in which your business primarily sells products.

There is one exception to what may seem like a normal delineation between the two. Engineering and construction companies are considered non-service businesses. That’s just one indication that this Tax Act isn’t always logical

One of the strategies right now is regarding businesses that are a mix of service and non-service activities. This may be, in the right circumstances, a way to classify as a non-service businesses and avoid the more stringent rules of a service businesses. This is definitely something you will want to discuss with an experienced CPA, first though. When you take positions like this with your tax filings, there are some specific rules to follow.

Time will tell how this all sorts out. We still don’t have any guidance from the IRS on this.

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