The Qualified Business Income Deduction: How business owners can collect a significant tax benefit
During tax time this year, business owners faced a dizzying array of changes, courtesy of the Tax Cuts and Jobs Act (TCJA) of 2017. In particular, many encountered the new concept known as the Qualified Business Income (QBI) deduction.
Or maybe they didn’t. A lack of awareness left this key provision of federal tax reform underutilized. And yet, proper planning might have saved many business owners considerable amounts on their 2018 taxes.
That’s especially true for high earners in certain professions such as health, law, and accounting, plus a few other skilled pursuits defined by the IRS as Specified Service Trades or Businesses (SSTB).
Those who start planning now, however, can adjust their 2019 filings to accommodate income thresholds and, perhaps, take advantage of a valuable tax benefit.
What is the QBI deduction?
The QBI deduction applies to all income levels but varies according to each business owner’s taxable income. While levels will be indexed for 2019, those earning under $315,000 married filing jointly ($157,500 all others) in 2018 qualified for a straightforward 20 percent deduction.
Those with larger taxable incomes (more than $415,000 for married couples filing jointly (MFJ) and other filers with earnings over $207,500) had limitations based on wages paid and equipment owned. In between the two incomes, there are phase-ins.
However, income exceeding $415,000/$207,500 from Specified Service Trades or Businesses (SSTB) don’t qualify for the QBI deduction. But business income from other sources may qualify for the deduction.
How to make an SSTB qualify for QBI deduction
As they plan for future taxes, SSTB filers and their CPAs can try several strategies to keep income below threshold levels and qualify for the QBI deduction:
- Accelerate expenses. For example, group planned equipment purchases into a single year.
- Coordinate business expenses and personal itemized deductions in the same year.
- Max out retirement contributions.
- Defer income.
- Develop forecasts to ensure you meet taxable income thresholds in future years.
Tax planning for sole proprietors
Sole proprietors with income exceeding threshold levels typically lack the employees and, often, the equipment that make the QBI deduction applicable.
Converting to an S corporation helps resolve this dilemma. By self-paying a fair wage, sole proprietors can take a QBI deduction equal to the lesser of 20 percent of the business income (after wages) or 50 percent of W-2 wages.
Others could evaluate the possibility of converting independent contractors to employees, for a QBI deduction that could outpace the cost of payroll taxes.
Tax planning for partnerships
All partnerships can compensate partners via guaranteed payments and/or distributions, but the QBI deduction is based on the partnership’s income, net of guaranteed payments. Partners who restructure guaranteed payments into priority cash-flow distributions and prior-income allocations might enjoy increased QBI deductions.
Tax planning for rental real estate owners
Under IRS rules, most real-estate income earned through triple-net leases – where the tenant pays the property taxes, insurance, and maintenance in addition to standard fees such as rent and utilities — is ineligible for the QBI deduction. Restructuring the lease to give the owner an active role in the activity could make the income eligible for the QBI deduction.
Property owners of buildings beyond their original depreciation lives should review expenditures for possible capitalization. This change increases the QBI deduction by categorizing those costs as unadjusted basis immediately after acquisition (UBIA).
QBI deduction tips
Business owners in various circumstances can consider a few more strategies to qualify for the QBI deduction. For instance, the “married filing separately” status rarely offers advantages, but it can make sense for SSTB owners married to high-earning W-2 employees if SSTB income falls below $157,500.
Remember, too, that the QBI deduction is limited to 20 percent of taxable income, which can be less than qualified business income when losses, income adjustments, and standard or itemized deductions are calculated. These taxpayers should consider boosting taxable income through such moves as converting taxable retirement vehicles to non-taxable Roth IRAs.
Of course, every taxpayer’s circumstance differs, so be sure to work with a tax planner well-versed in the intricacies of the QBI deduction.
Benjamin R. Bostic, CPA, is a manager at Boyer & Ritter with experience providing tax and accounting services for individuals, not-for-profit, and closely held business clients. Reach Ben at 717-264-7456 or firstname.lastname@example.org