Jane Dotson
The US Internal Revenue Service (IRS) has released regulations that classify life insurance as distinct from financial services for the purposes of Section 199A of the Internal Revenue Code. This means that insurance agents and brokers can qualify for a 20% tax deduction on their pass-through income, which is a significant benefit. However, this deduction is not available to higher-income taxpayers. The classification of insurance as separate from financial services has been the subject of debate, with some arguing that insurance should be considered a financial service, particularly when fees are involved rather than commissions.
| Characteristics | Values |
|---|---|
| Section 199A QBI deduction | 20% deduction on qualified business income (QBI) |
| QBI deduction eligibility | Sole proprietorships, S corporations, partnerships |
| QBI deduction eligibility based on income type | Income from SSTB (Specified Service Trade or Business) is not eligible for high-income taxpayers |
| SSTB definition | Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees |
| Insurance agents and brokers | Excluded from the definition of brokerage services and are eligible for the QBI deduction |
| Life insurance | Not considered a financial service for tax deduction purposes |
| Commission-based insurance sales | Excluded from the definition of "investing and investment management" |
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What You'll Learn
Insurance agents and brokers are excluded from SSTB
The Tax Cuts and Jobs Act, signed into law in 2017, introduced a new 20% tax deduction for pass-through entities, including S corporations, partnerships, and sole proprietorships, under Section 199A of the Internal Revenue Code. This deduction, known as the Qualified Business Income (QBI) deduction, is designed to reduce the tax burden on small businesses. However, it does not apply to all businesses and is subject to various limitations based on the type of business and its income.
Specified Service Trades or Businesses (SSTBs) are generally excluded from the QBI deduction. SSTBs are defined as businesses involving the performance of services in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing, and investment management. The Internal Revenue Service (IRS) has provided some clarification on the definition of an SSTB, specifically excluding real estate agents and insurance agents or brokers from the category. This means that insurance agents and brokers are not considered SSTBs and are, therefore, eligible for the QBI deduction.
The exclusion of insurance agents and brokers from SSTBs is significant as it increases the number of taxpayers eligible for the QBI deduction. However, it is important to note that the QBI deduction is subject to income thresholds. For tax year 2022, the deduction is not applicable to SSTBs when taxable income exceeds $440,100 for joint filers and $220,050 for other filers. It is partially allowed when taxable income is between $340,100 and $440,100 for joint filers and between $170,050 and $220,050 for other filers. Individuals with income below these thresholds are not subject to the limitations and can claim the full deduction.
For insurance agents and brokers who are also involved in brokerage services or have income from other sources, determining eligibility for the QBI deduction can be complex. In such cases, the strategy of separating QBI-eligible insurance business from non-QBI-eligible brokerage commissions and advisory fees may be considered. However, this approach can create additional complexity and expenses, and it may not always be worth the effort unless there are substantial insurance commissions involved.
It is important to note that the rules and regulations regarding the QBI deduction are subject to change, and taxpayers should consult with tax professionals or refer to the latest IRS publications for the most up-to-date information.
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Commission-based insurance sales are not investment services
Commission-based insurance sales are not considered investment services. This is because insurance is not considered a financial service for the purposes of Section 199A. The Treasury Department and the IRS agree that by operation of Section 1202(e)(3)(B), insurance cannot be considered a financial service.
This distinction is important for insurance professionals who want to retain the benefits of the QBI deduction. The QBI deduction, or qualified business income tax deduction, is a 20% deduction that applies to pass-through income. To qualify for this deduction, businesses must separate specified service businesses (SSTBs) from non-specified service businesses. The challenge is that running multiple businesses creates a layer of complexity and expense, and it may not be worth it unless there are substantial insurance commissions involved.
The controversy surrounding commission-based insurance sales is that advisors may be conflicted between recommending the best product for the customer and the product that earns them the highest sales commission. This creates a conflict of interest, as the advisor is no longer acting as a fiduciary for the client. Some professional groups refuse to admit advisors who receive commissions, as they believe that any type of commission business disqualifies those advisors from calling themselves "fee-only".
However, some advisors argue that they can best serve clients by offering a comprehensive menu of financial services, including insurance and annuity services. These advisors believe that having an insurance license helps them simplify client finances and provide ongoing reviews. They disclose to clients that they receive commissions from insurance companies, and that the clients are not required to use their insurance service.
Ultimately, the decision to offer commission-based insurance sales as an investment service is a complex one, involving regulatory, ethical, and business considerations.
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The QBI deduction and insurance
The Tax Cuts and Jobs Act (TCJA) introduced the Qualified Business Income (QBI) deduction, also known as the Section 199A deduction. This provision allows eligible taxpayers to deduct up to 20% of their QBI, as well as 20% of qualified REIT dividends and PTP income. The QBI deduction is applicable to tax years starting after December 31, 2017, and ending on or before December 31, 2025.
When it comes to insurance and the QBI deduction, there are some important considerations. Insurance agents and brokers are specifically excluded from the definition of financial services for the purposes of Section 199A. This means that insurance cannot be considered a financial service, and commission-based sales of insurance policies are generally not considered investment management for Section 199A. However, if an insurance agent receives a fee for providing investment advice, rather than a commission on sales, they may be considered to be providing financial services.
For hybrid insurance producers, who are also registered investment advisors (RIAs) or brokers, there are strategies to preserve the QBI deduction. One approach is to separate the QBI-eligible insurance business from non-QBI-eligible brokerage commissions and advisory fees. However, this can be complex and costly, as it involves running multiple businesses, maintaining separate books and records, and allocating overhead costs. Additionally, it may increase the risk of IRS audits if expenses are attributed disproportionately to the non-QBI-eligible financial services business.
It's important to note that the QBI deduction has limitations based on the taxpayer's income, the type of trade or business, W-2 wages paid, and the unadjusted basis of qualified property held by the business. The deduction may also be reduced for patrons of agricultural or horticultural cooperatives. To determine eligibility and calculate the deduction, taxpayers can refer to the instructions provided by the Internal Revenue Service (IRS) and seek guidance from tax professionals.
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Life insurance is not a financial service
Life insurance is a contract between an individual and an insurance company that promises a tax-free payment to beneficiaries upon the individual's death. It is not an investment or a financial service, but rather a safety net that provides financial protection for loved ones. While it can be an important tool for ensuring a family's financial stability, it does not constitute financial advice or wealth management.
The distinction between life insurance and financial services is important, especially when considering tax implications. In the context of Section 199A of the Tax Cuts and Jobs Act, which introduces a 20% deduction for qualified business income, the separation of specified service businesses (SSTBs) from non-specified service businesses is crucial. The Treasury Department and the IRS have clarified that insurance, specifically including life insurance, is not considered a financial service for the purposes of Section 199A. This means that insurance producers, agents, or brokers who are involved in both insurance and financial services may need to separate their businesses to retain certain tax benefits.
The decision to separate businesses to maximize tax deductions is complex and depends on various factors. It may involve additional expenses, record-keeping, and overhead cost allocation. Furthermore, it raises the possibility of IRS audits, as businesses may be tempted to attribute expenses to the non-QBI-eligible financial services business while maximizing income from the QBI-eligible insurance business. Therefore, while life insurance is not a financial service, the interplay between the two industries can impact tax strategies and business structures.
Life insurance is designed to provide financial security and peace of mind for individuals and their families. It helps protect against financial losses that may arise due to the death of a primary income earner. This can include covering mortgage or rent payments, final expenses, student loans, co-signed debts, or the cost of replacing services provided by a stay-at-home parent. By purchasing life insurance, individuals can ensure their loved ones have the financial resources they need to maintain their standard of living and achieve their goals.
In summary, while life insurance is not a financial service, it plays a crucial role in financial planning and security. It involves a contractual agreement with an insurance company to provide tax-free payments to beneficiaries upon the insured individual's death. The distinction between life insurance and financial services has tax implications, particularly in the context of Section 199A, and can impact business structures for those operating in both industries.
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The challenges of splitting business lines to qualify for QBI deduction
The Qualified Business Income (QBI) deduction, also known as Section 199A of the Internal Revenue Code, was established by the 2017 Tax Cuts and Jobs Act (TCJA). It allows eligible self-employed individuals and small business owners to deduct up to 20% of their QBI. The QBI deduction comprises two main components: the qualified business income and the real estate investment trust (REIT) or publicly traded partnership (PTP) components.
However, splitting business lines to qualify for the QBI deduction comes with its own set of challenges. Firstly, it raises the possibility of IRS audits, as business owners might be tempted to maximise expenses for their non-QBI-eligible business lines while minimising those for their QBI-eligible lines. This could result in increased scrutiny from the IRS.
Additionally, the recent QBI regulations' aggregation rules mandate that financial advisors must operate two entirely separate businesses to qualify for the deduction: one for insurance income and expenses, and another for all other revenue streams. This adds a layer of complexity to the business structure and operations.
Another challenge arises when a business has multiple lines, one of which is a Specified Service Trade or Business (SSTB). The proposed regulations include a de minimis rule, stating that if a taxpayer's gross receipts from SSTB activities are $25 million or less, the business will not be considered an SSTB if less than 10% of the receipts are from SSTB activities. If the taxpayer's gross receipts exceed $25 million, the business will not be considered an SSTB if less than 5% of the receipts are from SSTB activities. This rule adds complexity and requires careful consideration of the business's revenue streams.
Furthermore, the strategy of separating QBI-eligible insurance businesses from non-QBI-eligible income streams is complicated by recent proposed regulations. These regulations state that if a single business with multiple lines has total revenues of $25 million or less, and more than 10% of its income comes from investment-related activities, the entire business is considered an SSTB. This means that even the QBI-eligible insurance commissions would not be eligible for the deduction. As a result, businesses must carefully evaluate the potential benefits and complexities of splitting their business lines to maximise their QBI deduction.
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Frequently asked questions
The 199A deduction, or the Section 199A QBI, is a 20% tax deduction that applies to pass-through income.
Pass-through income refers to income from sole proprietorships and pass-through entities like partnerships and S corporations.
The 199A deduction is intended to lower the tax rate for unincorporated businesses, benefiting owners, shareholders, or partners.
An SSTB, or a specified service trade or business, is a business that provides services in fields like health, law, engineering, architecture, and financial services.
No, insurance is not considered an SSTB. The IRS has released regulations classifying life insurance as distinct from financial services for the purposes of the 199A deduction.
