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The 20% QBI deduction part 2: Planning strategies

 

The 20% QBI deduction part 2: Planning strategies

Sep 30, 2019

In part one of our QBI deduction series, we took a deep dive into the Tax Cuts and Jobs Act’s Internal Revenue Code (IRC) section 199A, which provides a 20% deduction for qualified business income (QBI) received by taxpayers from a pass-through entity. Specifically, we talked about how retirement plans can help you leverage this deduction. 

In part two, we’re going to examine the different planning strategies availablefor taxpayers who receive pass-through income from a specified service trade or business (SSTB) —and when it makes the most sense to use each strategy.

All SSTB owners will fall within one of the following three categories: 

  1. Those whose taxable income is above the threshold amount and can use a deductible retirement plan contribution to reduce taxable income to the optimum amount (aka the super deduction).
  2. Those whose taxable income is already under the threshold amount and should re-examine the benefit of “Rothifying” their retirement contributions/balances.
  3. Those whose taxable income is too high to ever get any §199A deduction who should “stay the course” and continue to make maximum deductible retirement plan contributions for all the long-established traditional reasons.

We’ll dive into these three categories below:

1. The super deduction

Let’s take this as an example: A is a partner in a law firm and is projected to have 2019 QBI of $421,400. Assume “other income” will approximately offset “other deductions,” so 2019 taxable income will also be $421,400.  

If no action is taken, the §199A deduction will be zero (fully phased-out).

 

2019 QBI

 

Actions taken

 

2019 taxable income

 

§199A deduction

$421,400

None

$421,400

Zero

$421,400

401(k) and cash balance pension plan setup, generating $100,000 deductible contributions

$321,400

$64,280


The recommended action is for the firm to adopt 401(k) profit sharing and cash balance pension plans before the end of 2019 that will generate $100,000 in deductible contributions for A and a reduction in QBI and taxable income to $321,400, resulting in a §199A deduction of $64,280.

Incredibly, the $100,000 deductible retirement plan contribution generates $164,280 of tax deductions.

Depending on the age of the professional and other practice demographics, typical “combo” plans can generate up to $200,000 or more of tax deductions/income reductions. The super deduction strategy can apply to professionals earning up to approximately $550,000.

2. Rothification

In this example,  B is the sole owner of a law practice, will make about $300,000 this year and will show about $300,000 in taxable income on a joint income tax return. Should B make a $50,000 SEP or profit-sharing contribution for 2019? 

B’s §199A deduction will be $60,000 without any retirement contribution, but only $50,000 if the retirement contribution is made. B is already in the “sweet spot” for the §199A deduction and, due to the reduction in the §199A deduction, each $1.00 of deductible retirement contribution only reduces taxable income by $.80.

B’s strategy should be to “Rothify” their retirement contributions by adopting a 401(k) plan and making maximum Roth 401(k) contributions, as well as maximum after-tax contributions (as may be allowable under the particular situation). 

Combining the maximum utilization of the new §199A deduction with the long-term benefits of Roth retirement accounts provides B a double tax benefit. 

3. Stay the Course

For SSTB owners making “too much” to get any §199A deduction, the strategy will be to continue to maximize deductible retirement plan contributions (usually using a 401(k) profit-sharing plan paired with a cash balance pension plan) for the long-established and well recognized benefits that existed prior to enactment of §199A.

Leveraging the 20% QBI deduction

If you have income from an SSTB and are searching for ways to meet the income threshold for the 20% QBI deduction, consult with your tax advisor or retirement plan consultant. They can do a cost benefit analysis to evaluate whether changes or additions to your existing retirement plan(s) or adding additional plans can help you take advantage of the QBI deduction.

If you have questions about the QBI deduction, contact us. Or continue reading on:

IRS Issues Guidance on Section 199A: The 20 Percent Passthrough Deduction

Final Regulations Issued for 199A Deduction – Its Impact on Farmers

Author(s)

Buss_Bob
Robert A. Buss, Jr., CPA, CEBS
Executive Director, Employee Benefits Services
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