Firm Asks IRS to Clarify 199A Treatment of Advertisement Income

October 1, 2018

CC:PA:LPD:PR (REG-107892-18)
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: Comments on Proposed Regulations under Section 199A

This letter provides comments on proposed regulations (REG-107892-18) (the “Proposed Regulations”) relating to the qualified business income deduction under Section 199A of the Internal Revenue Code of 1986, as amended (the “Code”). We appreciate the opportunity to provide comments on the Proposed Regulations and thank you in advance for your consideration of these comments.¹

INTRODUCTION

These comments are provided in response to the request by Treasury and the Internal Revenue Service (“IRS”) for comments on the Proposed Regulations under Section 199A of the Code, regarding the application of the new deduction for qualified business income (“QBI”). In particular, there is one issue regarding the meaning of “trade or business where the principal asset of such trade or business is the reputation or skill of one or more employees or owners” under Prop. Reg. Section 1.199A-5(b)(2)(xiv) that we request clarification on as it relates to certain advertising income commonly received by individuals and RPEs engaged in the business of producing, distributing, or broadcasting talk programs owned by the individual or RPE.

Section 199A(c)(1) of the Code provides that only items attributable to a qualified trade or business are taken into account in determining the section 199A deduction for QBI. Section 199A(d)(1) provides that a “qualified trade or business” means any trade or business other than (A) an specified services trade or business (an “SSTB”), or (B) the trade or business of performing services as an employee. Section 199A(d)(2)(A) provides that an SSTB is any trade or business described in Section 1202(e)(3)(A) (applied without regard to the words “engineering [and] architecture”) or that would be so described if the term “employees or owners” were substituted for “employees” therein. One of the trades or businesses described in owners” were substituted for “employees” therein. One of the trades or businesses described in Section 1202(e)(3)(A) is a trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees. Prop. Reg. Section 1.199A-5(b)(2)(xiv) limits the definition of a trade or business where the principal asset of such trade or business is the reputation or skill of one or more employees or owners to:

Prop. Reg. Section 1.199A-5(b)(3) contains two examples illustrating the application of this definition.

Example 8 addresses a fact pattern in which a well-known chef and sole owner of multiple restaurants, due to his reputation and skill, received an endorsement fee for the use of his name on a line of cooking utensils and cookware. The example states that the chef is engaged in the trade or business of being a chef and owning restaurants and such trade or business is not an SSTB. However, the chef is also engaged in a separate trade or business of receiving endorsement income, and this trade or business is an SSTB within the meaning of Prop. Reg. Section 1.199A-5(b)(1)(xii) and Prop. Reg. Section 1.199A-5(b)(2)(xiv).

Example 9 addresses a fact pattern in which a well-known actor enters into a partnership with a shoe company. The actor contributes her likeness and the use of her name to the partnership in exchange for a 50% interest in the capital and profits of the partnership and a guaranteed payment. The actor's trade or business consisting of the receipt of the partnership interest and the corresponding distributive share with respect to the partnership interest for her likeness and the use of her name is an SSTB within the meaning of Prop. Reg. Section 1.199A-5(b)(1)(xiii) and Prop. Reg. Section 1.199A-5(b)(2)(xiv).

In the preamble to the Proposed Regulations, Treasury and the IRS specifically requested comments on the application of the definition of a trade or business in which the principal asset is the reputation or skill of one or more employees or owners and the accompanying examples.

NEED FOR CLARIFICATION AND ADDITIONAL EXAMPLE

1. Advertising income received for on air advertising spots in which a program host may make positive statements about his or her experience with the service or product that is the subject of the advertisement should not be treated as endorsement income described in Prop. Reg. Section 1.199A-5(b)(2)(xiv)(A).

The comments received by Treasury and the IRS prior to the publication of the Proposed Regulations demonstrate the broad range of ways in which the “reputation or skill” category of SSTBs could be interpreted and applied. We agree with the position of Treasury and the IRS, as stated in the preamble to the Proposed Regulations, that “the reputation or skill clause as used in Section 199A was intended to describe a narrow set of trades or businesses, not otherwise covered by the enumerated specified services, in which income is received, based directly on the skill and/or reputation of employees or owners”. We believe additional guidance is necessary to address certain advertising income commonly received by individuals and RPEs engaged in the trade or business of producing, distributing, and broadcasting talk programs owned by such individuals and RPEs. We do not believe the trade or business of producing, distributing, or broadcasting news commentary and similar talk programs is properly included within the narrow set of trades or businesses that fall within the reputation or skill category of SSTBs. However, the definition set forth in the Proposed Regulations and the limited examples create some uncertainty on the matter, as further explained below.

The primary revenue generator for radio stations has historically been on air advertising. On air advertising has also become a significant revenue generator for individuals and RPEs engaged in the trade or business of producing, distributing, or broadcasting talk programs, such as news or current events commentary programs, on internet based platforms (e.g., podcasts and webcasts). Talk programs broadcast on radio or internet based platforms often sell advertising spots in which the program host delivers information about a specific service or product during the program, rather than taking a break to air pre-taped advertisements that have been produced by the companies paying for the advertising spots. There are multiple business reasons why some companies prefer to pay for advertising spots broadcast in this format as opposed to paying for air time to broadcast a traditional pre-taped commercial. For example, these types of on air advertisements may be more efficient and economical than pre-taped commercials since the advertiser is not required to expend time and resources scripting, recording, and producing a traditional commercial. Further, because a program host delivers these types of advertising spots during the program and these spots are typically shorter than traditional commercial breaks, program listeners may be less likely to tune out during the advertisement.

An individual host delivering this type of on air advertisement often will read a script describing the positive qualifies of the particular service or product that is the subject of the advertisement. In some instances, the host may choose to share his or her personal experience with the service or product. We are concerned that the language of the Proposed Regulations could be interpreted as converting income that is otherwise properly treated as advertising income into income received for the endorsement of products or services merely because the host makes such statements regarding his or her positive experience with the service or product. We think this would be an inappropriate result. As stated above, we agree with the position of Treasury and the IRS that the “reputation or skill” category of SSTBs should be limited to trades or businesses “in which income is received, based directly on the skill and/or reputation of employees or owners” (emphasis added). In the case of on air advertising spots in which the host of a talk show reads an advertisement for a service or product during the program, the income for the advertisement is not earned based directly on the skill and/or reputation of the host. Rather, the income is earned based on the size and demographics of the audience, since the goal of advertisers generally is to convey positive information about their services and products to as many individuals in their target demographic as possible. Further, the program host has no formal association with the service or product apart from any positive statements he or she may make about the service or product in the on air advertising spot during the program.

Income received for these types of advertising spots is notably distinguishable from the income received in the fact patterns described in Example 8 and Example 9 under Prop. Reg. Section 1.199A-5(b)(3). In Example 8, the chef is an expert cook operating several restaurants. The chef enters into an agreement in which his name is placed directly on a line of utensils and cookware. In the example, the chef is clearly leveraging his reputation or skill as a chef in his restaurant business to engage in a separate trade or business of receiving endorsement income for products relevant to his area of expertise. In Example 9, the actor contributes her likeness and the use of her name to a shoe company in exchange for a 50% interest in the capital and profits of the partnership and a guaranteed payment. In this example, the actor's primary trade or business is acting, and she is leveraging the celebrity status she gained through her primary trade or business to engage in a separate trade or business of contributing her likeness and the use of her name to promote shoes.

In contrast, when an individual or RPE is engaged in the trade or business of producing, distributing, or broadcasting talk programs owned by the individual or RPE on radio or internet based platforms, the income received for on air advertising spots delivered by the program host is not received in connection with a separate trade or business of making endorsements. The fact that the host may make positive statements about his or her experience with the service or product that is the subject of the advertisement during such on air spots should not convert what is in substance advertising income into endorsement income described in Prop. Reg. Section 1.199A-5(b)(2)(xiv)(A). This type of advertising income is received based on the size and demographics of the program, rather than based directly on the skill and/or reputation of the program host. Further, unlike in Examples 8 and 9 in the Proposed Regulations, the program host maintains no other association with the service or product apart from the host s positive on air statements about the service or product.

2. Additional Proposed Example.

To address the concerns discussed above, we suggest the final regulations include the following example.

Example (X): An RPE is engaged in the trade or business of producing, distributing, and broadcasting a talk program owned by the RPE in which a host discusses and comments on current events. The RPE generates revenue by selling on air advertising spots in which the program host will read a script describing the positive qualities of the particular service or product that is the subject of the advertisement. The host sometimes chooses to share his own positive experience with the service or product during these on air advertising spots. Notwithstanding such statements, the RPE and the host are not engaged in a separate trade or business of receiving fees to endorse services or products. The trade or business of the RPE is producing, distributing, and broadcasting the talk program owned by the RPE and the income received from the on air advertising spots is advertising income, which is not described in Prop. Reg. Section 1.199A-5(b)(2)(xiv).

Thank you for your consideration of our comments. If you have any questions, please contact the undersigned at (214) 969-1602 or Shelly A. Youree at (310) 203-6901.

Very truly yours,

Kathleen E. Gerber
Thompson & Knight LLP
Dallas, TX

cc:
Shelly A. Youree