Maximizing the 20% QBI Deduction for Service-Based Businesses
December 19, 2018
At the end of 2017, Congress passed the 2017 Tax Cuts and Jobs Act (“2017 TCJA”) that went into effect for 2018. For service-based business owners, one of the biggest potential benefits of this new tax law is the 20% deduction for Qualified Business Income (the “20% QBI Deduction”). However, there are several nuances to this deduction that need to be analyzed carefully to receive the maximum benefit, namely for accountants, doctors, dentists, lawyers, veterinarians, and chiropractors that operate their own practices.
Phase-out Limitations for Service-Based Businesses
First, you may have heard that service-based businesses were excluded from being able to take the 20% QBI Deduction. This is simply not true and was initially miscommunicated by several media outlets when the 2017 TCJA was first enacted into law. The 20% QBI Deduction is available for all businesses… but there are certain phase-out limitations for service-based businesses. If your personal taxable income is less than $315,000 for joint filers or $157,500 for everyone else, there is no limitation and you will get the full 20% QBI Deduction ($63,000 deduction for joint filers) on your individual income tax return. It’s important to note that the limitation is based on the taxpayer’s taxable income and not on the total income flow-through from the service-based business. However, when your personal taxable income reaches $415,000 for joint filers and $207,500 for all other filers, your 20% QBI Deduction completely phases out and you do not get the 20% QBI Deduction.
You might ask yourself, what if I estimate my 2018 taxable income to be between $315,000 and $415,000 (for joint filers) or $157,500 and $207,500 (for all other filers). In either case, you will get a portion of the 20% QBI Deduction. The amount of your 20% QBI Deduction is calculated using a math formula based on how close your taxable income is to the ceiling of the above-mentioned thresholds. If your taxable income is comfortably below the floor thresholds ($315,000 joint filers / $157,500 all other filers), then the calculation of your 20% QBI Deduction is actually fairly straightforward. Your 20% QBI Deduction gets more complicated if your taxable income is within or above the phase-out ranges mentioned above. Utilizing tax planning strategies to reduce your taxable income below the floor or at least to a lower portion of the phase-out range can save you a significant amount of income taxes.
Example of Service-Based Business Owner: Married Doctor
For example, the federal income tax bill for a married doctor with taxable income and qualified business income of $315,000, would be $49,059. If that same doctor had taxable income and qualified business income of $415,000, the federal income tax bill would be $96,629. So, on the additional $100,000 of income, the doctor will pay $47,570 in federal income taxes, a marginal tax rate of 47.6%! This rate is even higher than the highest marginal tax rate of 37%. This doesn’t even consider state income taxes, which could easily push the additional federal and state income tax rate over 50%.
Considering Maximizing Your Deduction?
As a service-based business owner, you should consider estimating your 2018 taxable income to evaluate any possible steps you might be able to take to maximize your 20% QBI Deduction. Not all strategies work for every service-based business so a careful analysis is needed. If you have any questions or would like further information regarding the 20% QBI Deduction and how it could benefit you and your service-based business, please contact one of Hoffman Clark’s consultants.