With the April tax deadline now passed, most of us (or, at least those who have already filed their returns) have seen the impact of the Tax Cuts and Jobs Act. The results and feedback have been mixed so far. For small business owners, there is a QBI (qualified business income) up to 20% deduction available. This new tax break comes with some caveats and potential need for complex calculation and planning. For those small business owners out there, how did you fare last year? How will the TCJA impact you this year? And maybe more important, do you know why?
Let’s start with the QBI deduction and what it means for small business owners. The first exception to this new rule is determined by what type of business you operate. The IRS has determined that personal service entities are subject to limitations on the deduction. Personal service companies are entities providing financial, brokerage, health, law, accounting, actuarial, or consulting services, but excludes engineering and architecture businesses.
For all business owners, there is a potential 20% net business income deduction (right off the bottom line after all expenses). For owners of Personal service entities, there is an income phaseout where at a certain point they can’t take the deduction AT ALL. Let’s call that income level (from all sources, including spouse wages) to be 315k for joint-filers. In order for them to still get some deduction, the strategy is often an aggressive tax deferral in the form of a 401k or defined plan and any other means of reducing their AGI.
The caveat to this is the complexity of the calculation, as there are add-backs to the business income. So even if a number of deductions are taken and aggressive strategies used to get the income below the limits, the actual QBI (20% deduction) is still reduced or limited. Understanding how these rule impact you as an individual taxpayer is the best way to ensure you are making the most of your financial situation.
Brian P. Pry, CPA, Financial Architect
The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.