As you’re probably aware, we’re working with some new tax laws as of January 1st, 2018. The tax change that will have the most impact for many business owners out there – particularly owners of pass-through businesses – lies in section 199a.
Section 199a specifies that qualified business income is eligible for a 20% across the board deduction on the owners’ personal tax returns. 20%! This is a big deduction, and falls in line with all the political rhetoric about making the country a more business friendly environment.
Unfortunately, not every business owner will be able to claim it. One of the more controversial aspects of section 199a is that the deduction phases out at certain levels of taxable income, if your business is considered a “specialized service business” (SSTB). In 2019, this phaseout range is $315,000 to $415,000 of taxable income for married people filing jointly, and $157,500 to $207,500 for everyone else.
What exactly is a specialized service business, you ask? It’s one whose principle asset is the skills or experience of one or more professionals. This includes medicine, law, accounting, financial services, athletics, and several others.
With the introduction of section 199a & the QBI deduction, there are a number of tax planning opportunities for business owners. Qualifying for the deduction and maximizing its benefit could easily have a significant impact on business owner’s total tax liabilities. This post will explore three different types of tax planning strategies owners of specialized service businesses may consider to maximize the benefit of the 199a deduction.
Income Reduction Strategies
The first, most logical way to maximize the QBI deduction is to find ways to reduce your taxable income. The lower you are in the phaseout range, the greater portion of the deduction you’ll qualify for. Note here that the phase out isn’t based on your adjusted gross income or modified adjusted gross income (which is common for most other phaseouts, like IRA/Roth IRA contributions). The QBI deduction phases out based on your taxable income, which is after you take itemized or standard deductions. Here are a couple ideas to consider.
Qualified Retirement Plan Contributions
Establishing & funding a qualified retirement plan is usually the low hanging fruit for owners of specialized service businesses. The best plan structure and form for your situation will depend on a number of factors, of course. And if you have employees, chances are you’ll need to make contributions on their behalf as well.
The usual suspects here are SEP-IRAs & solo 401(k) plans for those without employees, and 401(k) & profit sharing plans for those with employees. You can also tack on a cash balance plan or defined benefit plan if you want to be aggressive (and are comfortable with mandatory contributions each year). In either case, every dollar you contribute to a qualified retirement plan, both as an employee deferral or employer contribution, will be deductible. And, of course, every dollar you deduct gets you one dollar closer to the beginning of the phaseout range.