MLB Commissioner Bunts In Suggested Change for Section 199A Regs

October 12, 2018

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable William M. Paul
Principal Deputy Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Supplemental Comments on Proposed Regulations concerning the deduction for qualified business income under section 199A (REG-107892-18)

Dear Messrs. Kautter, Rettig, and Paul,

On behalf of the Office of the Commissioner of Baseball, the association that governs and provides oversight with respect to the 30 Major League Baseball (“MLB”) clubs, I am submitting these comments to supplement our comment letter on the recently proposed regulations¹ under section 199A² (“199A Proposed Regulations”) that was filed with the IRS on October 1, 2018.

This supplemental letter contains a discussion of the activities and nature of a professional sports franchise operated as a pass-through entity, a review of the statutory text of section 199A and other relevant sections of the Code, a review of the legislative history and Congressional intent with respect to section 199A, and a proposed example that concludes that owners of a professional sports club operated as a pass-through entity are allowed the full deduction for qualified business income under section 199A (the “199A deduction”).

I. Specific Request

Similar to our initial comment letter, our specific request in this supplemental letter is to replace Prop. Treas. Reg. § 1.199A-5(b)(3) “Example 2”³ with an example that accurately reflects the fact that neither professional sports clubs nor club owners perform the services described in section 1202(e)(3)(A). Sports clubs are engaged in a multi-faceted business that involves activities and operations relating to selling media rights, tickets, concessions, signage rights, sponsorships, merchandise and other goods, managing real estate, and creating entertainment content. This is in stark contrast to accounting firms, law firms, consulting firms, investment banking firms, and health care practices, whose sole and narrow business is to engage in the performance of professional services for their customers. Unlike the owners of such firms, sports club owners have no incentive to convert W-2 wage income into “qualified business income” for purposes of the 199A deduction; it is the athletes (and not the owners themselves) who would benefit from such abusive behavior.

By way of background, the 199A deduction is generally available for “qualified business income” from a “qualified trade or business.” Section 199A(d)(1) provides that the term “qualified trade or business” does not include a “specified service trade or business” (“SSTB”). Section 199A(d)(2) provides that the term “specified service trade or business” includes any trade or business “described in section 1202(e)(3)(A).” Section 1202(e)(3)(A)'s description of trades or businesses includes “any trade or business involving the performance of services in the field[ ] of . . . athletics.” The preamble to the 199A Proposed Regulations properly recognizes that the definition of an SSTB is “substantially similar to the list of service trades or businesses provided in section 448(d)(2)(A) and § 1.448-1T(e)(4)(i), as the legislative history notes.”⁴

Consistent with a common, ordinary reading of section 199A, the Conference Report for the “Tax Cuts and Jobs Act,” P.L. 115-97 (“TCJA”),⁵ and other legislative history, a professional sports club is neither a trade or business “described in” section 1202(e)(3)(A) nor one “provided in” section 448(d)(2)(A). A professional sports club does not provide the services described in section 1202(e)(3)(A) and is not a “personal services corporation” as that term is used in the Code. Rather, a professional sports club manages a multi-faceted business that is distinctly different from a personal services corporation. Accordingly, the business of a professional sports club is not an SSTB under section 199A, and its owners should be allowed the full 199A deduction.

This clear statutory construction should be reflected in a revised example in the final regulations.

II. Activities and Nature of a Professional Sports Club

Owners of a professional sports club (whether organized as a corporate or non-corporate entity) invest capital in a multi-faceted entertainment business that includes the operations of a sports franchise and, in many instances, the employment of over 1,000 individuals. For example, investors may organize a partnership that purchases a professional sports franchise entitling the partnership to realize stadium ticket revenues, signage advertising fees, proceeds from the sale of product placement sponsorships and club-branded merchandise and other goods and national and local broadcast income and obligating the partners to fund capital needs relating to the ownership (or lease) of a stadium or arena.

A professional sports club does not merely employ professional athletes, but rather employs hundreds of additional individuals who are responsible for conducting activities related to stadium operations, marketing, team operations, broadcasting and media, retail store operations, community engagement, and general and administrative functions. In fact, the substantial majority of time spent by a club's employees does not relate to playing in the sporting contests presented by the club.

Overall, the partnership's business involves a return of capital from a wide range of activities, none of which involve the partnership's or the partners' performance of services in the field of athletics (those services are performed by the athletes). This is further evidenced by the fact that neither the partners nor the partnership receive any W-2 wages in exchange for the performance of athletic services. A sports franchise is wholly unlike an accounting firm, law firm, consulting firm, investment banking firm, or health care practice, where the owners themselves collect W-2 wages or similar compensation in exchange for the performance of services for their customers.

III. Statutory Analysis

1. Professional sports clubs do not “perform services" as described in section 1202(e)(3)(A)

In light of the nature of a professional sports club's business, the plain meaning of the statutory text that is at issue here cannot apply to professional sports clubs or their owners. As noted above, section 199A cross-references section 1202(e)(3)(A), which applies to “any trade or business involving the performance of services in the field[ ] of . . ., athletics,” Thus, a sports club would be covered by the statutory text only if its business involved the performance of services. But under a simple and common-sense understanding of these words, that is not what a sports club does. It sells tickets and sponsorships, licenses trademarks and other intellectual property, creates digital content, engages in community activities, manages a stadium, and produces an entertainment product. None of these activities amounts to “performing services” in any usual sense of those words.⁶ The services being performed in connection with a sports franchise are those performed by the players, who are employed by the club — and in that regard, the club is receiving services, not performing them. A professional sports club is simply not the type of services business contemplated by the plain language of the statute (which addresses law firms, accounting firms, and the like — businesses that involve the direct performance of services for their clients).

The 199A Proposed Regulations follow this plain-meaning understanding of the statutory text. As correctly noted in the preamble to the 199A Proposed Regulations,⁷ and consistent with the definition of a trade or business generally, the character of a trade or business should be determined by reference to its profit-generating activities.⁸ Thus, for example, as the 199A Proposed Regulations acknowledge, a researcher or manufacturer of pharmaceuticals does not perform health services within the meaning of section 199A because their customers are not paying for personal medical services.⁹

The 199A Proposed Regulations also acknowledge that the definition of an athletic services SSTB requires a customer-facing performance of athletic services, as the regulations indicate that a sports broadcaster's trade or business does not involve the performance of athletics services.¹⁰ The sports broadcaster's revenues have some nexus to athletic services — viewers watch the program because they want to see the athletes perform — but the broadcaster does not provide such services to fans. The broadcasting business is an entertainment business. Like the sports broadcaster and similar to the researcher or manufacturer in the field of health, neither sports clubs nor their owners perform athletic services for fans.

Furthermore, the sports club trade or business, like the broadcasting business, involves the operation of a capital-intensive and multi-faceted entertainment business that relies on a workforce comprised primarily of employees who never take the field. For these reasons, the trade or business of a professional sports club should not be viewed as an SSTB in the field of athletics.

2. Distinction from trade or business of an athlete

There is a fundamental difference between the trade or business of a professional sports club and its pass-through owners (which compete in the same trade or business as a corporate professional sports club and its owners) and the trade or business of an athlete who “perform[s] services in the field of athletics,” earns wages, and puts no capital at risk.

The trade or business of an athlete involves W-2 wage income from the actual performance of athletic services in the field of competition. As discussed below, Congress intended through the SSTB rules to prevent such W-2 wage income from being converted into qualified business income that is eligible for the 199A deduction. If such an athlete established a corporation solely to earn income from the performance of his or her services, the corporation would be akin to a “qualified personal service corporation” under section 448. Similarly, if the athlete set up a pass-through entity to perform the same function, the entity should be treated as an SSTB under sections 1202(e)(3)(A) and 199A.

However, if a trade or business set up as a corporation would not be treated as, and would not be akin to, a “qualified personal service corporation” under section 448(d)(2)(A), then a similar trade or business set up as a pass-through entity should not be an SSTB for purposes of the 199A deduction. A professional sports club set up as a corporation is nothing like a personal service corporation, and therefore a sports club set up as a pass-through entity should not be treated as an SSTB.

Pass-through owners of professional sports clubs do not earn W-2 wages (or wage-like income) from the performance of athletic services; instead, they are capital investors similar to owners of corporations that are not personal service corporations. Allowing them the section 199A deduction is consistent with the text of section 199A, as discussed above, and does not offend any of the goals of that provision, as discussed below. Congress clearly intended such pass-through owners to receive the benefits of section 199A, to put them on par with corporate owners who received a tax rate reduction from the TCJA.

3. Professional sports clubs are not “described in” section 1202(e)(3)(A) or “provided in” section 448(d)(2)(A)

Congress chose to explicitly cross-reference section 1202 in section 199A, since the services listed in section 1202 are broader than those listed in section 448, but it nevertheless expected that Treasury and the Internal Revenue Service (“IRS”) would employ the concepts found in the statutory framework of section 448 to define whether a trade or business is an SSTB, since there is more regulatory and other guidance under section 448 than under section 1202. This is evidenced in the language of the TCJA Conference Report addressing section 199A. The TCJA Conference Report contains footnotes 44, 45, and 46 that all cite to regulations under section 448 for determining which services are within a proscribed field of service and which are not within a proscribed field of service.¹¹ The 199A Proposed Regulations acknowledge this Congressional directive in the preamble and in definitions of SSTB categories that largely track those in the section 448 regulations.

The section 199A test for an SSTB is whether a trade or business is “described in” section 1202(e)(3)(A); as the TCJA Conference Report provides, this test is met if the trade or business is “provided in” section 448(d)(2)(A). Although athletics are not mentioned in section 448, that section does address performing arts, and because these two fields are highly similar, the Congressional descriptions and directives regarding performing arts are instructive for the field of athletics. The scope of the performing arts field is described in footnote 45 of the TCJA Conference Report by reference to section 448 and the regulations thereunder. Those regulations provide that the performance of services in the field of the performing arts means the provision of services by actors, actresses, singers, musicians, entertainers, and similar artists in their capacity as such, “The performance of services in the field of the performing arts does not include the provision of services by persons who themselves are not performing artists (e.g., persons who may manage or promote such artists, and other persons in a trade or business that relates to the performing arts). Similarly, the performance of services in the field of the performing arts does not include the provision of services by persons who broadcast or otherwise disseminate the performance of such artists to members of the public (e.g,, employees of a radio station that broadcasts the performances of musicians and singers).”¹²

As provided in the relevant section 448 regulations, persons who are not performing artists (i.e., who are not actors and entertainers) are not treated as performing services in the field of performing arts.¹³ Similarly, persons who are not performing athletic services (i.e., who are not athletes) are not treated as performing services in the field of athletics. A professional sports club and its owners are not athletic performers, and therefore the sports club is neither “provided in” section 448(d)(2)(A) nor “described in” section 1202(e)(3)(A).

To find that a trade or business is “provided in” or “described in” one of those sections, it is not enough that the trade or business simply employs athletes.

4. Professional sports clubs are not personal service corporations

The list of specified services in section 1202 generally mirrors the list of specified services in section 448. Section 448 provides beneficial tax accounting rules for, among other entities, “qualified personal service corporations.” The specific benefit of section 448(d)(2)(A) is to allow qualified corporations to continue to use the cash method of accounting — which in most cases is used by individuals — as opposed to the accrual method of accounting — which is often used, and in some cases is required to be used, by businesses. In this instance. Congress made the decision to provide a benefit to individuals, including those who operate through a personal service corporation.¹⁴ The personal service corporations eligible for this benefit are defined in section 448(d)(2)(A) as businesses that “involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.”

Whereas section 448 thus provides a benefit to personal service corporations, section 269A serves as an example of Congress imposing a restriction (i.e., an anti-abuse rule regarding tax avoidance) on personal service corporations. Section 269A defines a personal service corporation as “a corporation the principal activity of which is the performance of personal services and such services are substantially performed by employee-owners.” A common example of a personal service corporation is a medical practice that offers the services of a single doctor or a law firm that offers the services of a single lawyer. In each case, the shareholder of the corporation is also the employee of the corporation who performs services for the corporation and for the ultimate service recipient, such as a patient or client.

The foregoing demonstrates that in both statutes (section 448 and section 269A), each of which preceded the enactment of section 1202, when Congress referred to a “personal service corporation,” it was focused on the performance of services by individuals, consistent with the commonly understood meaning of the term “personal service corporation.” It is a well-settled principle of statutory construction that when Congress uses the same words in multiple enactments, the words should be given the same meaning in each place. Under this principle, the term “personal service corporation” means the same thing in sections 448 and 269A, the list of enumerated businesses in section 448 is therefore limited to personal service corporations as defined in sections 448 and 269A, and that list in section 448 necessarily covers the same businesses that are listed in section 1202. Reading all three provisions together, then, the list of enumerated businesses in section 1202 (and therefore in section 199A) applies solely to personal service corporations — that is, to entities that involve the performance of services by individual employee-owners. Therefore, the cross-reference in section 199A to a “business involving the performance of services in the field[ ] of . . . athletics” must be read to apply only to an athlete's personal service corporation, and not to a professional sports club.

IV. Legislative History

The foregoing analysis concludes that based on a plain reading of the statutory text, professional sports clubs (as opposed to athletes) do not perform services described in section 1202(e)(3)(A), and thus their owners should be entitled to the section 199A deduction with respect to income from their clubs. This textual analysis and statutory conclusion can stand on its own, though it is also confirmed and supported by the legislative history of section 199A.

1. Similar treatment of corporate and non-corporate entities

As reflected in its title, the TCJA was specifically enacted to cut taxes and create jobs. A cornerstone of the bill was a dramatic 14 percentage point reduction in the top corporate tax rate, from 35 percent to 21 percent.

The fundamental purpose of the 199A deduction was described in the legislative history as follows:

Reasons for Change

* * * * *

“To treat corporate and non-corporate business income more similarly under the income tax, the bill provides a [17.4]-percent deduction for qualified business income of individuals.”

S. Prt. 115-20, at 19 (2017); see also H.R. Rep. No. 115-409, at 129 (2017) (emphasis added).

MLB and other professional sports leagues have clubs arranged legally as both corporate and non-corporate entities. There is no doubt that a professional sports club set up as a corporate entity will be able to claim the new, lower 21% top corporate tax rate. The exact purpose of the 199A deduction was to allow a similarly situated professional sports club set up as a non-corporate entity in the same trade or business to be treated “more similarly under the income tax,” by providing it a 20% deduction on qualified business income.

The Congressional intent was to treat the “business income” of a professional sports club earned by a pass-through entity similar to the “business income” of a professional sports club earned by a corporation. To do otherwise would treat sports clubs in the same trade or business differently, by providing one (corporate) a significant tax cut, and the other (non-corporate) no tax cut. This simply was not the intent of Congress.

The clear Congressional intent and purpose of section 199A was to provide a tax cut on business income of a flow-through entity (in the form of a tax deduction) that was similar to the tax cut on business income earned by a corporation (in the form of a tax rate cut) in order to provide an incentive to businesses to create new jobs. It would be a perverse result to have the 199A regulations strip away from the large number of professional sports clubs organized as pass-through entities (as opposed to those organized as corporations) the incentive to create a multitude of additional jobs in the many communities across the United States in which sports franchises are based.

Importantly, the Secretary of Treasury was given broad authority and directed by Congress in section 199A to “prescribe such regulations as are necessary to carry out the purposes of this section.”¹⁵

Treasury should use its broad authority to reflect this clear Congressional intent and purpose — as well as the purpose regarding SSTBs in particular, as described below.

2. Guardrails

As the section 199A deduction was being developed. Congress created “guardrails” to distinguish compensation for services received as a service provider (e.g., W-2 wages receives from an employer) from business income earned as a business owner. Only the latter would be eligible for the new deduction. This distinction was meant to prevent W-2 wage earners who perform certain services from setting up a pass-through entity in order to claim the 199A deduction with respect to their services income. For example, Congress wanted to prevent accountants earning salaried W-2 wage income from setting up a pass-through entity to convert such wage income into business income in order to get the benefit of the 199A deduction, thereby being treated more favorably than a salaried accountant who did not set up a pass-through entity.

This is evidenced in the following statements made during the development of the TCJA:

• “The framework contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income . . .” (September 27, 2017, “Unified Framework for Fixing Our Broken Tax Code”)

• “As we change the pass-through rates, it's important that we have guardrails around those rules.” (Treasury Secretary Steven Mnuchin, October 1, 2017, ABC's “This Week”)

• “Mnuchin said the administration would seek to put “guardrails” around rules for pass-throughs to avoid people using them as a loophole.” (Reuters, October 1, 2017)

• “The Tax Cuts and Jobs Act includes specific safeguards to prevent tax avoidance and help ensure taxpayers of all income levels play by the rules under this new fairer, simpler tax system. Our legislation will ensure this much-needed tax relief goes to the local job creators it's designed to help by distinguishing between the individual wage income of NBA All-Star Stephen Curry and the pass-through business income of Steve's Bike Shop.” (Ways and Means release, November 2, 2017)

• “Our bill provides a simple tax deduction for qualified business income, leaving regular compensation to be taxed at the individual rates. The mechanism involved uses existing provisions of the tax code, which businesses are accustomed to dealing with and have a large body of precedent behind them. The mechanism provides firm policing against anyone thinking about mischaracterizing one form of income as another in order to unduly lower their tax bill.” (Senate Finance Committee Chairman Orrin Hatch (R-UT), November 13, 2017, markup opening statement)

• “Our pro-growth legislation will help Main Street job creators by: . . . Establishing strong safeguards to distinguish between individual wage income and pass-through business income so Main Street tax relief goes to the local job creators it was designed to help most.” (November 24, 2017 House Ways and Means Committee Majority release)

Fundamental to this distinction is determining what constitutes income from the provision of services (such as W-2 wages) in certain activities and what constitutes business income from an investment of capital. This is highlighted by the Ways and Means Committee's reference to an individual athlete (i.e., Stephen Curry), and to the delineation between the “job creators” that section 199A was designed to help and “individual wage” earners who were not meant to be beneficiaries of this section of the TCJA. This concept was originally included in the House bill, where only 30% of the income from a pass-through entity qualified for the benefit. This 30% proxy was based on an assumption that income from a business was approximately a 30% return on capital and a 70% return on labor.¹⁶

All of this legislative history is consistent with the conclusion above that section 199A's cross-reference to section 1202 must be read as a reference solely to athletes' and other individual service providers' professional service corporations and similar entities, which employ individual wage-earners, not to multi-faceted business entities like sports clubs.

The guardrails described above were implemented through the SSTB provisions of section 199A, which effectively disallow the 199A deduction for wage-like income.

3. SSTB guardrails

In creating the SSTB guardrails, rather than creating new rules from whole cloth. Congress chose to leverage the existing statutory framework of two sections of the Code — section 1202 (“qualified trades or businesses”) and section 448 (“qualified personal service corporations”) — thereby avoiding introducing new concepts into the Code. The SSTB guardrails are intended to serve as a proxy for the capital versus labor distinction, with the goal of preventing the conversion of W-2 wage or wage-like income into qualifying business income under section 199A.

The relevant SSTB guardrails are defined in the statute as follows:

Sec. 199A(d)(2) Specified Service Trade or Business. — The term 'specified service trade or business' means any trade or business —

(A) which is described in section 1202(e)(3)(A) (applied without regard to the words 'engineering, architecture,') . . .

(emphasis added).

The description in section 1202(e)(3)(A) of a “qualified trade or business” includes a trade or business “involving the performance of services in the field of . . . athletics.” The distinction again being made is between a trade or business that involves the performance of services and one that involves a return on capital.

The TCJA Conference Report provides a more precise description of the types of business covered by section 1202(e)(3)(A) by looking to “service trades or business . . . provided in section 448(d)(2)(A).”¹⁷ To be a service trade or business “provided in” section 448(d)(2)(A), “substantially all” of the activities of the trade or business must involve the performance of services in health, law, and other fields.¹⁸ The regulations under section 448 provide that “[s]ubstantially all of the activities of a [trade or business] are involved in the performance of services in any field . . . only if 95 percent or more of the time spent by employees of the [trade or business], serving in their capacity as such, is devoted to the performance of services in a qualifying field.”¹⁹ Thus, even if Treasury and the IRS were to conclude that professional sports clubs engage in some athletic services by reason of their employment of athletes, as explained above, the overwhelming majority of the club's workforce is comprised of non-athletes, and clubs therefore would still not qualify as a trade or business “provided in” section 448.

For all these reasons, and consistent with the intent of Congress as reflected in the TCJA Conference Report, professional sports clubs are not “described in” section 1202(e)(3)(A).

V. Proposed New Example

We agree with the description of the meaning of services performed in the field of athletics that is found in Prop. Treas. Reg. § 1.199A-5(b)(2), titled “Additional rules for applying section 199A(d)(2) and paragraph (b) of this section.” This definition is consistent with the section 448 regulations and states the following:

* * * * *

(viii) Meaning of services performed in the field of athletics. For purposes of section 199A(d)(2) and paragraph (b)(l)(vii) of this section only, the performance of services in the field of athletics means the performance of services by individuals who participate in athletic competition such as athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing. The performance of services in the field of athletics does not include the provision of services that do not require skills unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events. Similarly, the performance of services in the field of athletics does not include the provision of services by persons who broadcast or otherwise disseminate video or audio of athletic events to the public.

(emphases added).

However, Example 2 in the 199A Proposed Regulations reflects neither a plain reading of section 199A nor the clear Congressional intent in the TCJA Conference Report regarding the application of the SSTB guardrails. Rather, Example 2 incorrectly assumes that a professional sports club is an SSTB in the field of athletics merely because it employs athletes.

In using its regulatory authority under section 199A(f)(4), Treasury should be guided by both the clear meaning of the section 199A statutory text and the legislative history in the TCJA Conference Report and should formulate an example in the final regulations to allow pass-through owners of professional sports clubs the 199A deduction with respect to the full amount of pass-through income from their clubs.

We specifically request that Example 2 of the 199A Proposed Regulations be replaced with an example that reflects the correct application of the terms “described in” as set forth in section 199A(d)(2), and “service trades or business . . . provided in section 448(d)(2)(A)” as set forth in the TCJA Conference Report, to conclude that a professional sports club is not an SSTB under section 199A.

As described above, professional sports clubs are multi-faceted businesses that do not perform services described in section 1202(e)(3)(A). Accordingly, we propose the following example:

“Example 2. B is an individual who is not a professional athlete. B has invested capital and is a partner in a Partnership that owns and operates a professional sports club. Partnership owns or leases a stadium. Partnership is involved in the trade or business of earning revenue from the sale of media rights, tickets, in-stadium concessions, stadium signage rights, sponsorships, and team-branded merchandise and other goods. Since Partnership is engaged in a multi-faceted business and is not engaged in the performance of services in the field of athletics, Partnership is not a trade or business “described in” section 1202(e)(3)(A) and therefore is not an SSTB within the meaning section 199A and paragraphs (b)(l)(vii) and (b)(2)(viii) of this section.”

Finally, while not controlling authority, the preamble to the 199A Proposed Regulations contains some misleading and incorrect statements. Accordingly, we would also recommend that the preamble to the final regulations clarify that Congressional intent was to prevent W-2 wage (or wage-like) earners from converting their W-2 wage income into business income that would qualify for the 199A deduction, by using existing definitions and provisions in the Code, including section 1202 and section 448.

Thank you for your consideration of these comments, and we look forward to working with you to properly implement this section of the TCJA.

Sincerely,

Robert D. Manfred, Jr.
Commissioner
Major League Baseball
New York, NY