Incorporating sole proprietorships, partnerships, S Corporations, and limited liability companies, the structures limit double taxation at both the corporate and individual levels. Specified-service businesses are those in which the reputation of a specified individual is a principal asset to the company.
The Tax Cuts and Jobs Act 2017 launched a 20% tax deduction focused on pass-through businesses. However, as tax accountants pore through the Internal Revenue Service’s Section 199a deduction for “qualified business income” (QBI), many business owners wonder whether they will qualify.
Qualified Business Income (QBI)
As considerably as specified-service businesses, a bit of distressing news for many specialists: As per the IRS, defined service trade or business (SSTB) comprises of a trade or business including the performance of services in the field of accounting, actuarial science, performing arts, health, law, consulting, athletics, investment management, financial services, investing and trading, dealing in certain assets or any trade business where the principal support is the status or skill of one or more of its workers.
The purpose of this threshold suggests planning strategies that may benefit business owners to understand the full advantage of the deduction. These methods apply strategic tax deductions, targeted income cut and generation, and other critical tactical items consolidated within an overall financial plan.
As QBI qualification is based on taxable income, increasing below-the-line deductions within charitable gifts could probably lower taxable income enough to overcome the total deduction. In extension, gifting securities with significant long-term embedded capital gains can append additional tax savings. Also, practising a donor-advised fund, which provides charitable contributions to be arranged for an immediate tax benefit and then awarded to charity over time, can recognize this strategy to be executed into a client’s long-term charitable legacy.
If the pair makes a philanthropic gift of $100,000 to a donor-advised fund, they would decrease their taxable income to below the threshold and be capable of meeting the total QBI deduction of $60,000.
Planning of Retirement
For those who have not earlier maxed out pre-tax donations to their IRAs or qualified retirement programs, building deferrals could recognize taxable income to reduce the 199a deduction. If the trade owner has not yet done so, building a profit-sharing 401(k) or defined benefit plan can effectively reduce income while maintaining their retirement saving aims.
Roth Conversion Strategy
For some, the problem may be ensuring they have enough taxable income to circumvent being limited by the overall boundary of 20% of taxable income. If already regarding converting from a conventional IRA to a Roth for other financial planning purposes, this approach could raise taxable income sufficient to help you achieve the full QBI. While this approach may offer an opportunity to maintain the full deduction, this will require to be weighed against the additional taxes acquired on the conversion.
Capital Gains Avoidance
Long-term capital gains are generally taxed at a lower rate than ordinary taxable income. However, it is essential to note that capital gains can damage QBI as they raise taxable income. Therefore, for a detailed service business owner with taxable income immediately on the income cusp of reducing deduction, realizing capital profits could be the difference between qualifying for the full QBI deduction and receiving no QBI deduction. While capital gains contribute to taxable income relative to the income thresholds, they do not increase taxable income for the 20% taxable income limit on the deduction.
Every individual situation contains its unique aspects, which may or may not warrant a revised planning strategy. But intelligent planning can open doors to take advantage of this critical new deduction for business owners.