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This is huge for those getting 199A

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  • The White Coat Investor The White Coat Investor 
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    Status: Physician
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    Joined: 05/13/2011

    If you are eligible for the QBI deduction without phaseout. The employer retirement deduction to QBI ends up effectively reducing your marginal tax rate by 20% for current vs. future comparison on those contributions.

    Assuming your current marginal tax rate is 35% and you think your marginal tax rate will be one tax bracket lower in retirement. Also assuming the TCJA brackets go away, that bracket would be 33%. Prior to the QBI deduction, different people might go either way (pre-tax or Roth.

    With the QBI deduction, your effective rate on pre-tax retirement contribution savings is 28%. Comparing that to a future 33% tax rate, makes it pretty much a slam dunk Roth contribution and/or Mega Backdoor Roth.

    Everyone’s situation is different. Their current vs. future tax rates may be different. Their projections on future tax rates (TCJA sunset, future increases, etc…) may be different. Their general view on Roth contributions, early retirement Roth conversions and desired pre-tax, taxable an Roth portfolio mix may be different.

    The one constant for everyone eligible for the QBI deduction is the it effectively reduces the tax deduction for pre-tax retirement contributions buy 20%. That changes the balance point of pre-tax/Roth contributions towards Roth contributions.

    Click to expand…

    Unless you’re an S Corp. Then you want tax-deferred employee contribution and mega backdoor Roth IRA employer contributions. And you have to reevaluate whether the S Corp makes sense at all. What a mess.

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #189239 Reply
    Avatar Complete_newbie 
    Participant
    Status: Physician, Small Business Owner
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    Joined: 01/03/2017

    Great find. More clarity? Definitely not.

    Guess I have to spend an hour or two to sift through this and decide what to do.

    kitces is on top of his game though and recently I’ve been reading his articles. On the money.

    #189240 Reply
    The White Coat Investor The White Coat Investor 
    Keymaster
    Status: Physician
    Posts: 4191
    Joined: 05/13/2011

    Great find. More clarity? Definitely not.

    Guess I have to spend an hour or two to sift through this and decide what to do.

    kitces is on top of his game though and recently I’ve been reading his articles. On the money.

    Click to expand…

    It’s even more complicated for you as a direct real estate investor.

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #189242 Reply
    Avatar jacoavlu 
    Moderator
    Status: Physician, Small Business Owner
    Posts: 1701
    Joined: 03/01/2018
    Earnest refinancing bonus
    mega backdoor Roth IRA employer contributions.

    Click to expand…

    this doesn’t exist, after tax contributions (first step of mega backdoor Roth IRA) are employee contributions

    employer contributions (match, profit sharing) to a 401k are always pretax

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #189243 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1617
    Joined: 02/01/2016

    I’m pretty sure WCI meant making employee after-tax contributions and either in-service rollovers to a Roth IRA or IRRs to a designated Roth 401k account in lieu of making employer contributions.

    This is especially true if your net self-employment earnings are < ((net self-employment earnings – employee elective contributions) / 0.8). In that case your maximum employee after-tax contributions = (net self-employment earnings – employer contributions * 2)

    For example, you maximize your employee elective contribution at your primary W-2 employer and you $50K in net self-employment earnings. If you make $10K in employer contributions, your maximum employee after-tax contribution = $50K – $10K * 2 = $30K. If you make it all as employee after-tax contributions your maximum employee after tax contribution is $50K – $0 * 2 = $50K.

    So now with the QBI pre-tax retirement plan deduction. That $8K effective taxable deduction reduces your employee after-tax contributions by $20K or 2.5:1.

     

     

    #189249 Reply
    Avatar robaxin 
    Participant
    Status: Physician
    Posts: 26
    Joined: 09/10/2018

    Beginning to understand but still mucky…

    Will be spending even more $ getting ready for 2019 taxes…first, the creation of S Corp, then buying quickbooks and learning it for payroll, and now may have to use a mysolo401k to setup a Fido account with Roth and megabackdoor Roth option.

    #189414 Reply
    jfoxcpacfp jfoxcpacfp 
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    Status: Financial Advisor, Accountant, Small Business Owner
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    Joined: 01/09/2016
    The one constant for everyone eligible for the QBI deduction is the it effectively reduces the tax deduction for pre-tax retirement contributions buy 20%. That changes the balance point of pre-tax/Roth contributions towards Roth contributions.

    Click to expand…

    Minor point – it is not a constant for those who are at or just above the phaseout of qualifying for 199a. In these situations, taxpayers will want at least some allocation to a traditional 401k. As @docnews stated, if you may fall into this class, you’ll need to wait until your QBI is calculated at the eoy (solo-k’s). For this reason, business owners should have a 401k plan with the Roth option to afford them that flexibility. (Note that this applies only to the employee contribution as the employer contribution is always pre-tax.)

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #189450 Reply
    Avatar EMPA 
    Participant
    Status: Other Professional
    Posts: 4
    Joined: 01/07/2019

    Do we need to subtract 199A deduction from our net income when trying to figure how much we can contribute for Employer portion of i401k?

    #189717 Reply
    ENT Doc ENT Doc 
    Participant
    Status: Physician
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    Joined: 01/14/2017

    The 199A deduction doesn’t affect the net income calculation. It’s assessed separately. My understanding from reading this thread is the employer contribution affects the QBI deduction, not the other way around.

    #189728 Reply
    Kon Litovsky Kon Litovsky 
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    Status: Financial Advisor
    Posts: 873
    Joined: 01/09/2016

    If your business income qualifies for the 199A deduction, there is a major wrinkle to…well…almost everything in your financial life. Your retirement planning has now been turned on its head such that you may even need a new individual 401(k) and tax-deferred contributions may no longer make sense.

    I may be all Roth all the time going forward in my WCI, LLC retirement accounts and all tax-deferred all the time in my partnership retirement accounts! It’s getting really wacky around here.

    Tax deferred retirement accounts are less valuable (a lot less valuable) than they used to be because tax deferred contributions are subtracted from qualified business income. For an S corp, it’s only the employer contributions, which makes becoming an S Corp a bit more attractive than it used to be.

    Oh man, this thing should have been called the financial planner/tax advisor employment security act.

    Critically, the introduction of the Section 199A deduction means that business owners must reevaluate their planning from the ground up, as even “obvious” decisions may need to be altered in light of the new rules. Case in point? Going forward, the Section 199A deduction will dramatically reduce the value of a tax-deductible retirement plan contributions.

    https://www.kitces.com/blog/199a-qbi-deduction-reduction-small-business-owner-retirement-plan-contributions-roth/

    This new “deduction-reduction problem” with pre-tax retirement contributions arises from the fact that the Section 199A deduction only applies to qualified business income, which is essentially the profits of a company. But when an S corporation makes an employer contribution to an employer-sponsored retirement plan, that contribution, itself, reduces corporate profits. Thus, there is less profit on which the 199A deduction can potentially apply. The sum of these moving parts is that, for some S corporation owners, a contribution to an employer-sponsored retirement plan will effectively result in a partial deduction, but still subject the entire contribution, plus all future earnings, to income tax upon distribution.

    Click to expand…

    I’ll break this down into 3 cases.  There are just tons of assumptions that make the results different for everyone (such as retiring in a low tax bracket and a low tax state vs. high tax bracket and high tax state), and one can move around (that is, which case you fall into) depending on the income.

    1) For docs who will be phased out regardless of what they contribute into a tax-deferred retirement plan, contributing to one (or two) will remain the best strategy.

    2) For docs who will be above phase out, it might be a good idea to do some tax deferred contributions to get into the phase out range.  How ‘low’ one wants to go is a good question to ask the CPA, but tax-deferred would work out well especially for those who need to really go deep by employing a Cash Balance plan (so basically around $150k contribution if your net is around $500k or so), otherwise you would be hopelessly phased out with just a 401k plan.  There is planning to be done here, depending on where in the income range you fall.  If you are on the low end of the phase out range, you might be better off doing just Roth, higher end – possibly some tax-deferred depending on where you are.  This is definitely a more complex calculation requiring tons of assumptions, but I wouldn’t let that confuse you.  If in doubt – diversify.  Do some Roth and some tax-deferred.  There is no way to make 20+ year projections without assumptions that can easily change the outcome one way or another.  So diversifying your tax liability is always the best approach.  If you are in a high tax state and will retire in a low tax state, that can easily give you an extra 10% deduction, so if your tax rate differential is expected to be well over 20%, then you are probably better off doing tax-deferred and then get as much of the 20% deduction as possible.  If your tax rate differential is going to be lower, then you can do more Roth and take as much phased-out 20% deduction as you can.  Again, this is such a big assumption since we have no idea what tax brackets will be in 20 years, so you can always err on the side of getting 20% now vs. 25% differential later, so the value of 20% is definitely higher than even a 25% tax differential that you might (or might not) get later on.  The higher the taxes will be in the future, the higher the value of this deduction now.

    3) For docs who are currently not phased out there could be an argument to do all Roth and take the deduction.

    I wouldn’t call tax-deferred accounts less valuable.  They are just as valuable (probably even more so now than ever), because they can be repurposed into Roth (in the case of a 401k plan where you can do Roth salary deferrals and in-plan Roth conversions when after-tax is not available due to practice demographics) and into a phase-out ‘dial’ in the case of a 401k for those close to phase-out and Cash Balance plan for those with higher incomes where you can specify your contribution to be just right for your specific situation.  For some, a 401k plan would work just fine, but for those with higher incomes, Cash Balance plan would be ‘the’ plan to get you into the phaseout range.  We also have to contend with more IRS enforcement of ‘fair’ compensation, so that’s also going to play a big role.  This will also be complicated by availability of retirement plan options for solo and group practices vs. W2 employees. One thing is for sure.  Don’t jump on any strategy until you look at the entire picture and understand the whole spectrum of options and what works best for you.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #189749 Reply
    Avatar grp2c 
    Participant
    Status: Physician
    Posts: 21
    Joined: 08/13/2017

    This is infuriating. Apparently, the instructions changed between the draft on 1/7/19 and final on 1/25/19.

     

    Under the header “Determining your qualified business income”, one line was added “It also includes other deductions attributable to the trade or business including, but not limited to, deductible tax on self-employment income, self-employed health insurance, and contributions to qualified retirement plans.”

    page 3 – https://www.irs.gov/pub/irs-dft/p535–dft.pdf

    page 50 – https://www.irs.gov/pub/irs-pdf/p535.pdf

     

    This is especially lame since the contribution to employee salary deferrals for solo 401k’s should be done by 12/31.  Had I know this I would have elected to have make the employee deferral a roth contribution.

     

    #189812 Reply
    Avatar grp2c 
    Participant
    Status: Physician
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    Joined: 08/13/2017

    Wait a minute … Are SEP ira’s considered a qualified retirement plan? Based on the link below I’m not sure they are.

    https://www.irs.gov/forms-pubs/about-publication-560

    The 535 instructions above state contributions to “qualified” retirement plans will reduce QBI. If SEP Ira’s are not qualified plans then it can be argued that contributions to them should not reduce QBI.

    #189814 Reply
    jfoxcpacfp jfoxcpacfp 
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    Status: Financial Advisor, Accountant, Small Business Owner
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    Joined: 01/09/2016
    This is especially lame since the contribution to employee salary deferrals for solo 401k’s should be done by 12/31.  Had I know this I would have elected to have make the employee deferral a roth contribution.

    Click to expand…

    Not solo-k’s. You have until the due date including extensions (10/15). Ask your custodian to change the classification of your contribution.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #189822 Reply
    jfoxcpacfp jfoxcpacfp 
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    Status: Financial Advisor, Accountant, Small Business Owner
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    Wait a minute … Are SEP ira’s considered a qualified retirement plan? Based on the link below I’m not sure they are.

    https://www.irs.gov/forms-pubs/about-publication-560

    The 535 instructions above state contributions to “qualified” retirement plans will reduce QBI. If SEP Ira’s are not qualified plans then it can be argued that contributions to them should not reduce QBI.

    Click to expand…

    I think this terminology can be used loosely in the pubs. For example, at this link, SEPs and SIMPLEs are listed on A Guide to Common Qualified Plan Requirements even though they are not specifically defined as qualified plans. My guess is that the deductions count toward reducing income for purposes of 199A.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #189836 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1617
    Joined: 02/01/2016

    Johanna is correct, their are different considerations of the term “qualified”

    You need to look at the underlying information . Earlier in the same paragraph it says; “It also includes other deductions attributable to the trade or business”

    SEP and SIMPLE IRA contributions are just as attributable to the trade or business as one-participant 401k and defined benefit contributions. Contributions to a traditional IRA are not.

    Think about it practically. SEP IRA and one-participant 401k employer contributions are calculated exactly the same and subject to the same limits. Why would one be a deduction and not the other?

    #189857 Reply

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