Tax planning strategies: how to maximize the deduction for eligible business income?

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20% QBI deduction for indirect income

The qualifying business income deduction (QBI) is the central provision of the Tax Reductions and Employment Act and applies from 2018 to 2025. Qualifying business income is aggregated from a corporation of persons, an S corporation, a limited liability company and a sole proprietorship, and the individual tax return is claimed. Overall, you take out 20% of a trade or business’s QBI, plus 20% of qualifying real estate investment trust dividends and qualifying income from publicly traded partnerships. There are three limits associated with the deduction.

  • Specified trades or service companies

The first limitation is designed to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction. Trades or companies with the provision of services in the following areas are subject to the limitation: health, legal, consultancy, athletics, financial or brokerage services or when the main asset is the reputation of the employee or owner.

The QBI or Section 199A deduction does not apply to trades or specified service businesses (SSTBs) when taxable income is greater than $ 426,600 for joint filers and $ 213,300 for other filers and is partially permitted when taxable income is between $ 326,600 and $ 426,600 for joint filers and between $ 163,300-213,300 for other filers (2020 tax year levels).

  • Salaries / Base not adjusted immediately after acquisition (UBIA)

The QBI deduction cannot exceed the greater of the following amounts:

a) 50% of the portion attributable to the taxpayer of wages W-2, OR

b) 25% of wages plus 2.5% of unadjusted base (in depreciable property) immediately after acquisition

This limitation applies to all businesses when taxable income is greater than $ 426,600 for joint filers and $ 213,300 for other filers and is partially applied when taxable income is between $ 326,600 and $ 426,600 for joint filers and between $ 163,300 and $ 213,300 for other filers (2020 tax year levels).

It is important to note that S corporations pay their owners W-2 salaries, but sole proprietorships and partnerships do not. This can impact how this QBI throttling is calculated.

  • Limitation of taxable income

The 20% QBI deduction is limited to 20% of taxable income regardless of net capital gain income. The 20% taxable income limit applies to the combined qualified business income of the taxpayer from all businesses, while the previous two limits are applied at the activity or trade or business level.

Checklist for maximizing the QBI deduction

Here are some planning tactics around the various limitations that can help you optimize your QBI deduction. This checklist is not exhaustive and there is some overlap between the categories.

  • If you have little or no qualified business income, see if there are any opportunities to become a business owner, such as an employee becoming a consultant. Remember to take into account all the considerations, as a set of benefits.
  • If you are a specified, phased-out trade or service business, consider filing separately rather than jointly; or establish a separate business, separate entity, or become a C corporation. Be careful as some rules limit these tactics.
  • If you are subject to salary limits / UBIA, consider hiring employees rather than contractors; salary increase; the purchase of assets; become an S corporation instead of a partnership or sole proprietorship. Remember to take into account all factors, such as any increase in payroll taxes and a benefit package provided to employees.
  • If you exceed the taxable income threshold, consider deferring income and speeding up spending, or making a contribution to a pension plan to reduce taxable income for the current year.
  • If you are subject to the 20% taxable income limit, consider trying to increase taxable income, for example by taking a second job.
  • There are also other planning strategies, such as aggregating multiple business units to optimize the three components and boundaries (QBI, Wages, UBIA).

Example – Reduce taxable income to avoid phase-out

Facts

  • The bride and groom make a joint declaration
  • The taxpayer has a job that earns $ 250,000
  • The spouse owns a business with an income of $ 150,000 (a specified business or service business)
  • Other income of $ 60,000
  • Taxable income above the threshold of $ 421,400 (threshold TY19)

Results

  • Column 1: No QBI deduction because the taxpayer is above the threshold.
  • Column 2: The spouse makes a maximum contribution to a SEP plan of $ 27,950. This reduces taxable income below the threshold and results in a QBI deduction of $ 5,366.
  • Column 3: The combination of the SEP deduction and the QBI deduction results in a total tax savings of over $ 11,000.

Consulting Services – Show clients the ROI

As tax professionals provide advisory services and provide their clients with tax planning strategies, it is important to emphasize the return on investment, so that clients can see the value of the services. that is, how much they save compared to what it costs them to do the extra work. Point out that you are allowed to reduce their tax bill as long as you follow the law. The value of a good tax professional is finding tax savings opportunities for their clients and QBI is a good place to start!

Resources

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Mike D’Avolio, CPA, is a Senior Tax Analyst at Intuit ProConnect Group. D’Avolio has been a small business tax expert for over 20 years and serves as the primary liaison with the Internal Revenue Service on questions of interpretation of tax law. He manages all technical tax information and supports tax development and other groups by providing them with current tax law developments, tax law analysis and in-depth testing of Intuit’s professional tax software products, including Lacerte, ProSeries and ProConnect tax online.

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