[Update after publication: The original post included an error which affected a great deal of the post and its recommendations. It has now been corrected and updated. The original post stated that the “50% of wages” limitation applied to service business owners with a taxable income under $157,500 ($315,000 married. That is not the case. I apologize for the error.]
The Tax Cuts and Jobs Act of 2018 (TCJA) established a brand new deduction that professionals and business owners need to be aware of. Unfortunately, they made it quite complicated, making that task somewhat difficult. In this post, I'll boil it down to what you need to know about the deduction.
The deduction reduces the tax due for owners of pass-through businesses, which basically means any self-employed business that is not a C corporation. That means sole proprietorships, partnerships, S Corporations, and LLCs taxed as sole proprietorships, partnerships, or S Corporations. The reason for this deduction is that C corporations received a monstrous tax cut, when the maximum corporate tax rate was cut from 35% to 21%. This tilted the playing field in the business world, providing an advantage that did not previously exist to C corporations at the expense of their competitors structured as pass-through entities. This deduction is designed to help even out the playing field.
Size of the Deduction
The deduction is 20% of your Qualified Business Income (QBI). QBI is ordinary business revenue minus ordinary business expenses, i.e your profit. Remember that wages paid to you by your S Corporation are not QBI- they're an expense to the business, not business income.
How much of that 20% you get to take as a deduction may depend on as many as four factors:
- The nature of the business
- The taxable income of the business owner
- How much the business pays its employees
- How much property the business owns (in a few situations)
The Nature of the Business
Let's start with the nature of the business. There are basically two categories here: a personal service business and a non-personal service business. If the business is a personal service business, the deduction is eliminated at higher incomes. A non-personal service business does not have its deduction limited at higher incomes. What are personal service businesses? If you're reading this blog, there's a very good chance at least one of your businesses is a pass-through personal service business. In general, they're talking about high-income professionals like:
- Physicians
- Attorneys
- Veterinarians
- Podiatrists
- Optometrists
- Chiropractors
- Accountants
- Financial advisors
- Consulting firms
- Professional athletes
Interestingly, engineers and architects are specifically excluded.
The Income of the Business Owner
Assuming you own a personal service business, your income determines whether you qualify for the deduction. In 2018, the defining income is a taxable income (line 43 on the 1040) of $157,500 ($315,000 married.) The deduction phases out from $157,500 to $207,500 ($315,000 to $415,000 married). In addition, the deduction is also limited to 20% of the taxpayer's taxable income, so if all of the household's income is QBI, then any deduction you take will reduce the size of the pass-through deduction.
How Much The Business Pays Its Employees
The deduction may be reduced by how much the company pays its employees, but only for high-income business owners (i.e. taxable income over $157,500 ($315,000 married). In that case, the deduction is the lesser of 20% of QBI OR 50% of what the business pays its employees in wages. This is unlikely to be a factor in a company with a low profit margin and a lot of employees. That business owner will likely just get the 20%. However, a company with a high profit margin and few employees may be severely limited. In fact, a company with no employees at all (such as a typical physician sole proprietor paid on a 1099,) will get no deduction at all because 50% of $0 is, well, $0.
How Much Property the Business Owns
Alternatively, and again only for high earners, instead of having the deduction reduced by the 50% of wages rule, it can be reduced by 25% of wages AND 2.5% of the basis of the business's qualified property. The larger of the 50% of wages or the 25% of wage + 2.5% of basis is the maximum deduction, up to 20% of QBI. This “basis rule” would apply to a business with a great deal of property, such as a real estate investing business.
This flowchart may help you understand how to apply the various rules.
The Nitty-Gritty
Now that we've discussed the rules, let's talk about how they could apply in a few situations common among readers of this site. Then we'll talk about some strategies now available due to these new rules.
The Hospitalist
Okay, let's consider a hospitalist with a taxable income of $200,000 married to a stay at home parent. The hospitalist is an independent contractor paid on a 1099. She has no employees. How large is her deduction? $40K, 20% of the taxable income.
The Employed Physician
Consider an academic pediatrician with a taxable income of $150,000. He is an employee of the university hospital. What is his deduction? $0. He doesn't own a business and this is a deduction for business owners.
The Private Practice Internist
Now let's consider an internist who is the sole owner of his practice, structured as an LLC taxed as a sole proprietorship. He is married to a stay at home spouse and the couple has a taxable income of $200,000. Well, since the couple's taxable income is less than $315,000, he qualifies for the whole deduction. 20% of the taxable income of $200K is $40K. The other limitations do not apply since taxable income is under $315K married. Note that the QBI is likely quite a bit higher than $200K.
The Private Practice Internist with a Partner
The same internist as above takes on a partner. The LLC is now taxed as a partnership and they split hours, call, and profits 50/50. So when the internist and his wife go to do their taxes, the limiting factor is still the taxable income of $200K, so the deduction is $40K. The other partner's husband is a radiologist and their taxable income is $500K. That couple doesn't get a deduction.
The Internists Hire a Doc
The internists have decided to hire a doc. They're going to pay him a salary of $200K. The practice is getting busier and the doc works hard. The QBI of the business rises to $700,000. The first partner couple now has a taxable income of $250K. The second partner couple now has an income of $550K. The first partner's allocable share of QBI is $350K. 20% of $350K is $70K. However, the deduction is limited to 20% of their taxable income, or $50K. The other partner married to the radiologist still doesn't get a deduction, and of course the third doc is an employee and so doesn't qualify for the deduction.
My Practice
Let's say I make $250K at my practice, taxed as a partnership. My allocable share of QBI is $250K, my allocable share of wages is $50K and no property is owned by the practice. Unfortunately, my wife and I have this other business, which raises our taxable income to $1 Million, well above the $415K limit. So we get no deduction from the $250K of QBI from the practice. Without WCI, we would have had a deduction of $50K.
My Side Gig
Let's say the QBI for WCI, LLC (taxed as an S Corp) is $800,000. Since that is more than the $315K limit, the 50% of wages rule will apply. There are only two employees, Katie and I, and total wages are $300,000. It is NOT a service business (it sells ads and books), so the $315K-$415K limit does not apply, and owns almost nothing for which there is a significant basis, so we'll ignore the 25% of wages + basis rule. What is the deduction? 20% of $800K is $160K. 50% of wages is $150K. The deduction would be $150K.
I hope those examples are helpful to you in understanding the rules. Now let's get into some strategies you may be able to employ in order to lower your tax bill.
Strategies to Maximize Your Deduction
# 1 Change from Employee to Independent Contractor
Take a doc married to a non-earner. Let's say she makes $250K as an employee. She talks her previous employer into contracting with her new business instead of employing her as a person. Since she'll be covering the benefits and the employer share of the payroll taxes, she successfully negotiates payments of $300K per year. Perhaps their taxable income is $200K, which is the limiting factor on their pass-thru deduction, which is 20% of taxable income, or $40K. However, she does have to pay some additional payroll tax. But instead of paying 1/2 of the payroll tax on $250K ($11,604), she pays all of the payroll tax on $200K ($21,759). However, she gets a deduction for half of that, or $10,879. Overall, she pays an extra $10,155 in tax and gets an extra $40,000 as a deduction. Assuming a marginal tax rate of 29% (24% federal + 5% state) that deduction is worth $11,600. This strategy has resulted in lowering her tax bill by $1,445. PLUS, don't froget that the employer paid her more due to her savvy negotiating. If you assume the old employer covered that extra $10,155 in taxes, she really came out $21,755 ahead by becoming an independent contractor.
# 2 Hire Employees
Although this doesn't apply to service businesses if your taxable income is under $157,500 ($315K married), non-service businesses over that limit could potentially increase their deduction by hiring or paying employees more due to the 50% of wages rule. This could incentivize you to hire employees instead of bringing on partners.
# 3 Lower Your Taxable Income
Here's another strategy. Remember that the income limitation on service businesses is based on the taxpayer's taxable income. If your taxable income is anywhere close to the $157,500-$207,500 ($315-415K married) limit, reducing it can give you a significant deduction. What are good methods of reducing your taxable income? Well, you not only have deductions available that reduce your adjusted gross income (above the line deductions like contributing to tax-deferred retirement accounts and HSAs) but also below the line deductions such as contributing to charity (or a donor-advised fund) assuming you itemize. Those are always good ideas to lower your tax bill, but they're even better ideas if you are anywhere near those limitations on this deduction.
# 4 Raise Your Taxable Income
Of course, just to keep things complicated, RAISING your taxable income can also increase the size of this deduction if you are limited by the 20% of taxable income rule. So much for simplifying the tax code.
# 5 Get Rid of the Service Business
If you ever needed motivation to get out of medicine and do some other kind of non-service business, it's an even better idea now. Did you see the anticipated deduction for WCI, LLC above? A plastic surgeon making WCI kind of money doesn't get that deduction. However, realize that extra income from a side gig could eliminate the deduction from your practice if it boosts your taxable income too much.
# 6 Stay at Home Parent
The tax code has always favored a couple where one member is not working. Now, in some situations, this could be even more favorable thanks to this deduction. Many two doc couples will be phased out of the deduction where just one of them might still get it.
# 7 Pay Yourself More
If you're a non-service business S Corp, and your deduction is limited by the wages you're paying yourself, consider paying yourself more. The downside to that is you pay more Medicare tax, so you have to take that into account when making the decision. This is a big deal for Katie and I, so I thought I'd do some calculating.
Let's say WCI, LLC makes $1.5M this year. What is the ideal amount we should pay ourselves to minimize our taxes? For every dollar we pay in wages, our QBI goes down and our Medicare tax bill goes up, but our deduction goes up. Our marginal tax rate is going to be somewhere around 42%.
So if we paid ourselves $300K, we'd have a QBI of $1.2M and a Medicare tax bill of $8,700. Our deduction would be the lesser of $240K or $150K. After applying our marginal tax rate, the deduction would be worth $63,000, for a savings of $56,127 (remember part of the Medicare tax is a deduction).
What would happen if we paid ourselves $500K instead? The QBI would drop to $1M and the Medicare tax bill would rise to $14,500. So the deduction would be the lesser of $200K or $250K. Our wages are now clearly too high, since we're limited by the 20% of QBI rule and paid those extra Medicare taxes for nothing. The optimal answer is somewhere between $300K and $500K.
I'm sure a better mathematician than I could write an equation to sort this out. But let's try $400K. At $400K, 20% of QBI would be $220K and 50% of wages would be $200K and the Medicare taxes would be $11,600. Total tax savings would be $74,836. That's going to be pretty close to optimal for us, especially since we're going to have to choose what we'll pay in wages before knowing exactly what the QBI will be for the year.
Bottom line, by paying ourselves $100K more, we reduced our tax bill by about $19K.
I hope that explanation of the pass-through deduction is helpful for you. I'm sure there are lot of strategies out there that I haven't even thought of. For example, some are wondering if doctors will now form co-ops, which are not technically personal service businesses. It will be interesting over the next few years to see all the ways people come up with to increase this deduction.
What do you think? What other strategies have you thought of to maximize this deduction in order to lower your tax bill? Comment below!
So it seems to me that it now only makes sense to have an S Corp if your taxable income is greater than $315k and you don’t qualify for this deduction anyway. Otherwise, the S Corp drastically lowers the size of the deduction in excess of any tax savings you might get from avoiding some of the Medicare tax.
Here is the crux of the matter for my situation: I’m a retired partner who receives a proportionate share inasmuch as I retain some ownership but as I do not materially participate in the business my income on Sched E is passive income. While my income is at risk, I do not pay payroll taxes. I’d certainly like to take the pass through deduction but not sure if passive income qualifies. An6 insight?
I should mention that I do receive a K-1
How do you figure it works for multiple dba’s under one LLC? Example: LLC sole owner taxed as an S-Corp has (1) medical business and (2) a retail business optical shop. Can you get the deduction on the non service related retail business income?
Good question. I don’t know. But if not it seems pretty easy to split the businesses.
By splitting the businesses, do you mean placing the retail services into it’s own LLC? If so, this entity would also want to be taxed as an SCorp yes?
This blog post answers among other things the question about splitting off opticals:
https://solobuildingblogs.com/2018/03/04/how-the-new-tax-law-affects-solo-doctors-part-2/
To make a long story short, you’re subject to the W2 limitations assuming you’re over the phaseout limits so will have minimal pass through deduction. Given the hassles (cost and time) of running another business (licenses, tax prep, credentialing, payroll) it probably isn’t worth it. If you pay your optician $30,000, 50% of W2 is $15,000, 20% of this is $3000. At the 35% bracket this is $1050 tax savings. Not worth it for more hassles.
WCI/SBB: Has your interpretation of this changed? The way I’m seeing this, unfortunately, is that if we have passive income from separate business(es), even though they are not specified services, we cannot take 20% QBI deduction on the passive income because our *total* taxable income (inclusive of medical income and passive income) exceeds the limits. Would you agree?
There is no limit on taxable income for non-specific service businesses. That’s only for specified service businesses like doctors.
So you interpretation is that if total income is a sum of $500K medical business + $1M passive income, you can take the 20% deduction on the $1M (assuming the greater than / lesser than calcs appropriately done for W2 wages and property)
Yes. That’s what I’m doing this year. I assume by passive income you mean business income not investment income.
Yes sorry, not including investment income. Thanks for your replies!
I think I’ve figured out the magic number, please feel free to check my work.
You want your W-2 wages to be 28.5714% of your non-wage profits. This will give the highest number possible between 50% W-2 wages and 20% QBI.
Or for your example, 1.5M in profits, you want 28.5714% to be in wages, or $428,571. Your 20% QBI is $214,285,80 and your 50% wages is $214,285.50. I don’t think the MCR tax affects this magic number but I might be wrong on this point.
Thanks man, nice work! Now if you could just accurately forecast my revenue for me. 🙂
Cool! How did you do it?
There’s very likely an algebraic way to plot two equations and see where they intersect but I just made a spreadsheet and through trial and error that’s what I got.
Yea I’m working on that – it’s an optimization problem. I’ll update when I finish
Here’s a question I don’t think has already been asked –
Wife is sole proprietor and will be claiming QBI deduction
I have W-2 income
Together we will be under $315000
We currently do NOT have the cash flow to max out my 403b and max out her tax-deferred retirement accounts. She has a SEP-IRA (and yes, I know you prefer Solo 401k!).
Anyway, because we will NOT be contributing as much as we are allowed to our tax-deferred accounts, would it better to preferentially max out my 403b rather than her SEP-IRA? Before this tax law, I would have said SEP-IRA because then her self-employed income would be down, and thus we would save on the extra medicare taxes. But now it seems, we might as well max her QBI as much as possible (because the QBI deduction would save us more than paying the extra medicare tax) and shunt our retirement contributions to my 403b.
Just wanted to make sure I am thinking about that correctly. Thanks!
First of all, a sole proprietor SEP contribution IS subject to Medicare taxes (and FICA taxes). That’s because the profit is reported on line 12- and that number goes to firm SE. the sep deduction is on line 28 of 1040 so won’t affect Medicare taxes. If she’s taxed as S corp then this is different- no Medicare tax on SEP contribution.
Yes, assuming both retirement accounts have favorable expense ratios then it makes sense to minimize QBI with a SEP contribution. 403b plans have higher asset protection than IRAs if this is a consideration for you.
That’s right, it does change if you’re incorporated. Good point.
I think SEP-IRA contributions come out AFTER QBI, so I don’t think it matters does it? Are you using your SEP-IRA contribution as a business expense?
What is this employee leasing thing? Will doctors earning around 500K become eligible if they are part of the employee leasing structure?
Not sure what you’re referring to.
what do you think WCI?
A service business could also spin off an employee-leasing entity, to get around the professional service restrictions, according to Kenneth Brier, a partner at tax-planning firm Brier & Ganz based outside Boston. Employee-leasing entities tend to charge mark-up prices as a way to make a profit.
For instance, instead of paying its attorneys $200,000 a year, a law firm could pay its leasing spinoff a marked-up price of $250,000 per employee — shifting profits from the law firm to the leasing entity. While the lawyers in the new spin-off unit would be doing legal work just like before, Brier said he believes their new employer could qualify for the deduction as an employee-leasing company.
https://www.bloomberg.com/news/articles/2018-02-05/here-s-the-trump-tax-loophole-your-accountant-can-blow-wide-open
Interesting. Sounds a bit like the potential loophole of forming a co-op.
I’m having a hard time wrapping my head around this, as tax law and its associated language has always hurt my brain. Can someone help me out?
Wife is a stay at home mom (no income)
My W2 salary is 125K
I also have a professional speaking and consulting business (LLC) that generates around 100K yearly (via 1099s). We file as married, so we are definitely under the 315K.
Two questions:
1. What will my deduction be?
2. Will I still have to itemize my travel/business expenses (hotels, flights, etc) for the speaking/consulting business? I keep hoping there will be a standard deduction that makes this unnecessary given how much I hate it (it’s always around 17K or so in expenses), but I’m pretty sure the answer is no.
Thanks in advance!
#2: You can claim a standard per diem deduction, but it’s probably much lower than deducting actual expenses.
Itemizing shouldn’t be a big deal though. You can use a single credit card for all business expenses, use a travel expense app or use a 3rd party card service that tracks and categorizes everything for the entire year. All you really need is total expenses and the amount spent on M&E.
Thanks, Chris. You’re right, the standard deduction is much lower so I’ve got to keep track, and I need to get better about doing it in real time. It would be so much easier if I wasn’t always trying to maximize spend on specific credit cards. While playing the credit card game makes expense tracking harder, it’s worth it in my opinion. For example, we flew Emirates first class from NY to Dubai (free 3 day stopover) en route to our honeymoon in Italy. I took 3 showers on the plane! We did it all on points, which means that the tickets cost about 1000K each (as opposed to the 22K they would have cost outright).
I think I’d rather spend $22K than $1M on a ticket, but I guess you’re probably a lot wealthier than I am. 🙂
Hehehe! 1K. 🙂
1. Should be around $20K, no?
2. Itemize is the wrong word. Those aren’t itemized/standard deductions, they’re business expenses. So if you don’t keep track of them, you don’t get them.
Thanks so much! Just a quick note to say thanks also for the great content. I’m a professor with a pretty lucrative side hustle who has benefited tremendously from your advice. I was reading the responses to your content on real estate the other day and was pretty shocked by all the grief you got about transparency. I think you are more than transparent enough. It sounds like you have to endure that kind of hostility often? In thinking about starting my own blog (I’m a sleep neuroscientist and there is PLENTY of interest in sleep, hence my speaking/consulting/coaching side hustle), I’ll obviously have to grow a thicker skin. Again, thanks for all you do. WCI is one of my favorite blogs.
Glad you enjoyed it. Yes, a thick skin is pretty handy on the internet.
I got sone good news. My CPA said I will only owe $13,000 more in federal taxes instead of his original estimate of $35,000, because I switched employment in September and maxed out all my retirement accounts.
I had put $9500 in the 401A at the old employer (5% of salary through September) and maxed out the 457 at $24,000. Then I put $14,500 in the new employer’s 401K. also maxed out my HSA (the employer put in $2000, so mine was $3750 more). With the $30,000 going into my SEP, I knocked away a WCI inspired $81,750. I also started a brokerage account and put $5000 in this and $10,000 in 529 plans. That’s a record for me, almost $100K.
The CPA estimate did not take all this “off the top” money into consideration.
Thanks again to WCI for the site, book, blog, and the advice here!!
As I’ve said many times- a physician’s largest tax deductions are retirement account contributions. Not only do you get the deduction, but you’ve still got the money!
Indeed, I’ve been pondering about using Cash Balance plans to help group practice partners get at least partial deduction. What’s interesting is that for a group that sponsors a CB plan, some docs might be phased out whiles others can take the deduction. So QBID law adds another benefit in favor of Cash Balance plan for group practices. However, as before, the tail shouldn’t wag the dog, and all factors should be considered (including employer contribution cost), but it looks like this makes Cash Balance plans even better suited for group practices, so each partner can potentially set their own contribution amount that should allow at least some of them to get partial QBID.
Oh, you mean using the cash balance plan to get the taxable income down low enough that you can get the pass-thru deduction too? Good idea, but obviously it depends on the people. If they’re all married to other high earners, probably not going to make a difference!
Exactly, but the interesting thing is that in a group plan some might make it and some might not, and it might vary year to year which camp one ends up in, but it becomes yet another tax planning tool that makes a CB plan worth it because in many cases it can make a big difference.
WCI : if you were not a S Corp, but a 50/50 partnership with just you and the wife, then you would NO deduction?
As I understand it, I am limited by the wages paid by my company. Since the only employees of the company are my wife and I, if we were a partnership we would have no employees/wages and thus no deduction. I’d love to find out I’m wrong, but that’s my reading of it.
Wouldn’t this just be the same scenario as a sole proprietor? I would think if a sole proprietor is eligible for the deduction, a partnership would be as well.
Yes, but the limiting factor is the 50% of wages factor.
I’m 72 y/o, so my wife and I have RMD + Soc Sec income. Since these both count towards taxable income on 1040 line 43, I suppose they count towards our qualifying max of 315,000. Does anyone know if there is any possibility that either of these may not count?
I would expect them to count since it looks at taxable income.
@solobuildingblogs: I think the wages limit is 50% of W-2 wages, period. You don’t have to take 20% of that. So in your example $15,000 would be the deduction; at 35%, tax savings would be $5250. Starting to look more attractive, particularly if you’re making a ton of money in your optical, and have the flexibility to creatively increase your w-2 wages.
You might be able to shift a medical technician or admin staff from your medical business, or employ one of them part time in the optical business. You would not want to put your optometrist there, because then it becomes a specified service and subject to limitations.
There is more benefit when you have additional sources of passive income and you can put them under the umbrella of a single business entity. If you have an umbrella LLC (or multiple LLCs) that rents equipment, rents office space, sells retail, for example. You mentioned also ASC ownership income… it will indeed be interesting to see if that counts as service-related.
Great blog by the way.
I’m still so confused.
Maybe I can get some help.
My wife and I filed jointly this year with a total income/AGI of $400,000 with taxable income being $325,000 (All W2 jobs). Our total income this year will be higher from our W2 jobs to about $600,000, and I am also planning on moonlighting this year and adding at least ~$100,000 more of 1099 income.
Should I make an LLC or S-corp for my 1099 income? Best way to reduce my tax burden? How much can I put into retirement and what is the best way?
This post is about the pass-thru deduction, but you’re asking questions about S Corps and retirement plans. S Corps (or an LLC filing as an S Corp) is primarily to save Medicare taxes on distributions at that income level. If you have no employees, an individual 401(k) is usually the best option for a retirement plan at that income level, and is also the best way to reduce your tax burden. If this is a service business, it doesn’t sound like you’re going to get the pass-thru deduction.
Any other pathologists out there? I’ve been tinkering with an idea: we are an independent lab with three main parts of our business – we provide laboratory services (i.e. manufacturing tissue slides), professional pathology services (i.e. diagnosis), and we have an in house billing service. Only the middle one is definitely exempted from the QBI deduction, the other two are unclear. I though that we could potentially divide into two entities (either a separate lab entity, or a separate billing entity) that “charges” the other a fee for services, so that the income can be segregated into an entity that could potentially qualify for the QBI deduction. Anybody had similar discussions with a professional about this type of structure?
Lots of people talking about stuff like this. I certainly would be discussing it with my accountant/attorney/advisor/partners if I were you.
I think that the tail should not wag the dog. How you structure your businesses has a lot of impact on your retirement plans as well. There are controlled/affiliated group considerations, and some arrangements might be more beneficial than others, so I would look at the whole picture, not just QBID. Also, the types of plans you might have have impact on the applicability of QBID, such as Cash Balance plan, for example. Oftentimes CPAs are not well versed in the retirement plan angle, so structuring a business just for the tax benefit (if possible) can impact your retirement plans, thus I’d consider all facts and make a decision based on the results of the cost benefit analysis as to whether a specific arrangement is better vs. the alternatives. This might require the input from an ERISA attorney as well to make sure that any arrangement will actually work as intended. For example, even if you split off part of your business, you will still be considered a controlled/affiliated group for retirement plan purposes.
Thank you for posting such useful information. I am a software consultant who works in 1099 and your article says Engineers are excluded but consulting firms are included so I dont know where I fit. Could you please clarify this?
I believe an engineer working as a consultant would be able to get this pass through deduction.
Thank you!
Question, QBI does not include W2 salary correct? it is essentially the distribution on your K1 from special services corp. So hypothetically if you have 2 partners make 1,000,000 you so you are way above ss withholding. If you pay out 315k as a distribution, and take 685k as w2 income you would receive 63k deduction, and compare with paying reasonable salary of say 350k(median salary of your specialty) and 650k distribution. difference is 2.9% medicare tax increase or 650K -315 x 2.9% or about 9715.00. savings is 24,5700 – 9715.00 or 14,855 dollars tax save per partner. Now if you have multiple other businesses with K1, you would also potentially save on those also. Contrast that with taking 350 w2 salary and 685 distribution, you lose all of the other deductions from your other K1s correct? Say you have a bunch of real estate investments with K1s, surgery center, gas pipelines. Can someone help provide guidance? Sorry if this is not clear.
I’m not sure exactly what you’re asking. Can you clarify? But no, W-2 income isn’t qualified business income. According to this, that includes W-2 income paid to you by your S Corp.
https://www.thetaxadviser.com/issues/2018/apr/understanding-sec-199A-business-income-deduction.html
Actually, your W2 is included in the net income, so you are completely phased out. The only hope one might have is with a Cash Balance plan. So if your net is $550k, and you are old enough, you might be able to stash $200k in a CB plan, give yourself a $250k W2, and get a smaller than 20% deduction on the $100k distribution. This is just barely making it, and you won’t save that much with this method, but it is the only way to get into the range for someone making ~$500k. In some cases you might actually get the full 20% deduction. But that’s about it. No other way to get into the range other than to take tax deductions using retirement plans (or some other way, which is not going to work consistently unless it is a retirement plan). If you have other businesses, forget it, because your net income is additive. But that’s a good problem to have. With multiple businesses if you dont own 100% of them you can potentially open lots of retirement plans (401k, Cash Balance, etc), and that can save you a LOT more money than QBI will. Just have to be very careful how you approach this.
Thanks so much. So if your income from your personal service business is too high above 415k, that phases you out from all other pass through deductions from all other businesses such as a surgery center dividend, real estate K1 pass through income, etc? Wish I could do multiple retirement accounts but these other companies are not controlled by me. They may not have significant wages but have are real estate so 2.5% of 25 million x my share is still a lot. So b/c of personal services business, I would be eliminated from deduction on all other businesses?
No. But the personal service business income no longer qualifies. For example, I get no pass thru deduction for my clinical practice, but I do for WCI, LLC.
Real estate might be fine, actually – you might be able to get a QBI deduction on that income. You really need to work with a good CPA on this, it is very complicated, especially the interaction of various types of businesses with the QBI deduction. You can’t open a retirement plan for real estate investments. You can’t contribute surgery center dividend to a retirement plan as well as this is passive income. If the other companies are not controlled by you, you can still discuss with other partners the option of setting up a retirement plan.
Thanks so much for advice WCI. Thanks Kon, definitely don’t do my own taxes, have an accountant sort through the several hundred pages of mess that is my tax return. So glad to have a forum like this to help other individuals in our fortunate but unique situations.
WCI,
Not sure if you have already commented on this or not, but it looks the IRS is putting the brakes on people trying to gain the deduction by moving from W-2 to Independent Contractor for the same company, as you suggest one does above.
https://www.msn.com/en-us/money/small-business/the-irs-is-cracking-down-on-this-small-business-tax-break-what-it-means-for-you/ar-BBLPyRd?li=BBnbfcN
Have you seen this announcment?
-DoD
That, and many other things that IRS just put out regarding the new tax deduction. A lot of ideas came out before the IRS guidance that came out recently, so many things that people already started doing are already wrong. I would wait until total clarity and consensus before doing anything that is questionable.
Sometimes it pays to be a procrastinator.
First I’ve seen it. I’m sure there will be more guidance to come. I agree it can often be a good idea to delay implementing new stuff.
I own a C-Corp that files as an S-corp and am a solo physician provider with 3 employees, one of which is my spouse (office manager). If I plan on filing jointly with my spouse who is an employee how will that work since only non-employees are eligible for this new 199A deduction? Does it mean I cannot take the deduction? We are not married yet but will be by the end of the year so I’m not familiar with tax implications of filing jointly just yet. I do know that our income will likely be in the range of the phaseout (315,000 to 415,000).
Nobody is familiar with it since no one has actually done the 199A deduction paperwork. But you should still be able to get the deduction if you otherwise qualify for it. Just having your spouse as an employee of the business doesn’t disqualify you.
Did you mean an LLC that files as S corp? I’m not sure how you can be a C corp and file as an S corp. You can take the deduction if you are an LLC that files as an S corp. The AGI phaseout range is for a joint return ($315k-$415k). So if your income is in the phaseout range or higher, by using a 401k with profit sharing you are able to adjust your net income to fall into the phaseout range (if it is higher than $315k limit).
We are a c-corp and filed last year as an s-corp by submitting a certain form my account prepared for us.
So did you convert to S corp? Because I don’t know how you can be both a C and an S. You can not take the deduction as a C corp.
If you have an LLC taxed as S corp, you can take the deduction. If your income is in the phase out range, you can use a 401k with profit sharing to put yourselves outside of that range (and claim a bigger deduction). Your CPA should be able to do a projection for you for 2018, as this stuff is definitely complex since you have to take into account all aspects of your specific tax situation before you know how much of a net deduction you will get.
So I’m a 1099 ER Provider, roughly 372,000/year before SEP/health premiums, etc. beginning of the year I was a lock for the 20%, but now this new 199A seems to say sorry
You get 0% now. Is this officially law or can it be tweaked still? I’m hoping it’s not true cause 20% of 300,000 is quite the deduction
So I’m a 1099 ER Provider, roughly 372,000/year before SEP/health premiums, etc. beginning of the year I was a lock for the 20%, but now this new 199A seems to say sorry
You get 0% now. Is this officially law or can it be tweaked still? I’m hoping it’s not true cause 20% of 300,000 is quite the deduction
So with a retirement plan you can decrease your taxable income for the purpose of the 199A deduction. So if you contribute say $55k to a 401k or a SEP, your net will be ~$317k (less if you deduct the health insurance). So if you are a married filing jointly you can still take the 20% deduction. Your CPA should do an analysis for you though, as individual details do matter.
If married, you should be in the phaseout range, so you should get something.
If single, and your taxable income is above the phaseout range, you get nothing because your business is in a specified service industry.
https://evergreensmallbusiness.com/sec-199a-deduction-phase-calculations/
The problem is (as we’ve seen before) that if one has an LLC/pass through, there is a W2 requirement in the phaseout range. Thus my recommendation for working with a CPA to get this figured out.
I am at 372,000 base, 30K Schedule C deductions takes me to 342K. 1/2SE (12.5K), SEP Max (55K) and Health Insurance premiums (15K) will put me around 260K taxable before 24K deduction so QBI Deduction should be about $51,000 at 24% puts $12,500 in my pocket. Plus child credit.
Are physicians now excluded per the IRS guidance regarding healthcare being a service industry?
Somehow architects got out of it?
That’s correct. That’s not a new change though. It’s been that way since the law was passed.
From what I understand though, if you are married and can get taxable income lower than 315K it does not matter the type of business , correct?
This is from section 199a:
Q8. In 2018, I will report taxable income under $315,000 and file married filing jointly. Do I have to determine if I am in an SSTB in order to take the deduction? Is there any limitation on my deduction?
A8. No, if your 2018 taxable income is below $315,000, if married filing jointly, or $157,500 for all other filing statuses, it doesn’t matter what type of business you are in. You will be able to deduct the lesser of:
a) Twenty percent (20%) of your QBI, plus 20 percent of your qualified REIT dividends and qualified PTP income, or
b) Twenty percent (20%) of your taxable income minus your net capital gains.
What I’m in unclear on is what happens if your taxable income is 350k but all from SSTB designation?
That’s right.
High level clarifying comment that I can’t find a straight answer for…
I get paid as an independent contractor on a 1099, but have not set-up a business entity. Not an LLC, not a corp, nothing. My payment checks are written up in my name, and I cash them into my personal bank account. Can I still claim the 20% deduction without setting anything up? Thank you!
Yes, you can. You are not a “nothing” (see your question), you are a sole proprietor and as such have the same access to the new pass through deduction as other business entities. I am in the same boat as you. I’m retired from full time EM practice, now doing occasional ER shifts, chart reviews for an insurance company and consulting work – all on 1099’s. Since I’m married filing jointly, and my total taxable income for 2018 (including any W-2 income, IRA RMDs, cap gains, interest, dividends, 1099 income, gambling winnings, whatever) will be <315K, I believe I'll be entitled to take 20% deduction on the 1099 income. Of interest, the new rules will benefit the needy! – I've chosen to donate much more to charity this year, just to keep the taxable income under 315K. (Of course I could keep more by not donating, but it served as a motivator for me and my wife to get the satisfaction of the full 20% and give to good cause).
Since itemization is no longer an avenue can you really decrease your taxable income by just making charitable contributions?
I don’t see why itemizing deductions is not in play. According to TurboTax, for 2018 “If you itemize, you can deduct cash donations of up to 60% of your adjusted gross income (AGI).” Also, living in Florida we are not exposed to state income tax. I’m not a tax accountant, I just play one on TurboTax each year. So let me know if you think I’m missing something.
It’s still in play, but not for many given the new higher standard deduction.
Peter, thank you.
I’ve been keeping track of all my un-reimbursed business expenses. But I’ve been getting conflicting tax advice.
Can I:
1) Deduct eligible un-reimbursed business expenses from my gross income?
AND
2) Take the standard deduction ($12k)?
AND
3) Take the new 20% pass-through deduction as well?
1. yes on schedule C. This assumes you are self employed.
2. Yes
3. yes. It doesn’t require itemizing to get the 199A pass-thru deduction.
Thanks for this post. Please help in clarifying if I am eligible for this deduction.
Military ER doc with W2 Wages ~$120K
Moonlighting as a sole proprietor, no employees, 1099 income of ~$90K.
So clearly total income is under threshold for married filing jointly (no sig income from my spouse).
If I am eligible, would the 20% be solely of my 1099 income, or would it be my total income (1099 + W2)?
Thanks in advance!
Yes.
Just the 1099 income.
It’ll be the lesser of just 1099 or total taxable income. So your situation will be the 90,000 minus schedule C deductions will be your 20%.
Turbo tax had the QBI portion live now so you can play with it