The new tax law contains one of the most exciting provisions we have seen in recent years.
There is a new Qualifying Business Income (QBI) deduction that could allow you to receive up to 20 percent of your business income totally tax-free. For small business owners, this could equate to thousands of dollars in savings.
There are very few deductions allowed by the IRS that don’t require you to spend money. This is one of those where you get to keep the money and take the deduction.
Hoops To Jump Through
As you can imagine, the IRS has placed some pretty tight restrictions around this deduction. Not everyone gets it, and it is far from automatic. There are some hoops to jump through.
Depending on your profession, income, other activity on your return, and how much you pay your employees, you could get up to the full 20 percent deduction or be disqualified entirely. Some of those things are in your control and some are not. For instance, you can pay a little more in wages if needed to get the full deduction, but you can’t make a disqualified business type qualify for the deduction.
So, Who Qualifies?
If you have income from a small business (sole proprietorship, partnership or S Corp), you may qualify. If your income is over $315,000 for married filers ($157,500 for other filing statuses), then you may have some additional requirements.
Real estate rental income qualifies, so long as it is not from triple net leases. If you have rental properties, you will want to review your leases to make sure you qualify for the QBI deduction for your rental property.
Some taxpayers will get the full 20 percent deduction, some will just get a portion of it, and others will miss out entirely. Let’s talk about each group.
Keep in mind there are many other requirements, including a few terms the IRS invented just for this deduction, but here are the basics.
Here are the people who should get the full 20 percent:
- Total taxable income is less than $315,000 for married filers ($157,500 for other filing statuses) and they have positive income from almost any business activity (including rental properties).
- Income is not from a service and the business meets all other requirements (wages, property, etc.) with no income limit.
Here are the people who will only get a portion of the deduction:
- People with businesses providing services like law, medical, financial, investing, etc. (Specified Service Trade or Business) with total taxable income between $315,001 and $415,000 for married filers ($157,501 and $207,500 for other filing statuses).
- Businesses that don’t pay sufficient wages to their employees (measured as at least 50 percent of business net income) with total taxable income over $315,001 for married filers ($157,501 and $207,500 for other filing statuses).
Here are the people who do not qualify for the deduction:
- People with businesses providing services like law, medical, financial, investing, etc. with total taxable income over $415,000 for married filers ($207,500 for other filing statuses).
What Can I Do About It Right Now?
This is the most important question. If you have not already talked to your tax advisor, you need to meet now. Whether you qualify for the deduction and how much it is worth to you may hinge on a few moves you can make before the year-end. Once the calendar turns to January, most of our strategy options disappear.
Here is the list of people who definitely need
to see a tax professional before the end of the year:
- Anyone in a service business. If you are a higher earner, you are most likely to lose this deduction. So, some careful planning around income shifting, income smoothing, and wage optimization may be the difference between getting the full 20 percent and getting nothing.
- Anyone with a small business with total income over $315,000 if married ($157,500 for other filing statuses). There are some simple moves you can make at year-end to max out the deduction.
- Anyone with multiple businesses especially if one has losses or does not pay wages. The deduction for one of your businesses can be “stolen” by another business if you are not careful. There are some complicated grouping elections that can be made, but they must be considered carefully as they are permanent elections.
The business tax code has not been simplified; it has been made more complicated. If you are a small business owner, maximizing this 20 percent QBI deduction should be a top goal of your tax strategy.
If you’re not sure if you are well-positioned to make the most of it, now is the time to act. Paying a professional to adjust your approach can save you thousands of dollars in tax.
At Adam Shay CPA, PLLC, we have made understanding this deduction (and other new tax law opportunities) a major
component of our planning and education for our clients. All our CPAs and tax advisors stand poised to assist you with this process.
Adam Shay, CPA (NC License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. Over the last several years, the firm has grown from a one-man shop to one of the largest firms in the Wilmington area. Adam focuses on minimizing taxes and improving the financial results of entrepreneurs. Those results are obtained by taking a proactive approach to all aspects of taxes and financials. Adam is actively involved in supporting the Wilmington entrepreneurial and startup community. He earned a Bachelor of Business Science in commerce from the University of Virginia and a Master of Business Administration (MBA) degree from the University of Maryland. During his spare time, Adam enjoys spending time with his two boys and wife, Sarah, as well as coaching and watching sports and spending time outdoors.