By Jon L. Ten Haagen, CFP ®
I hope you are all having a good May and it looks like we finally gotten a real spring. I have been looking for a long time for the right person(s) to merge my company with. The wait is over and I would like to introduce you now – shortly we will have a more complete article specifically about our new venture.
I am in the process of bringing in two young men as part of my ‘business succession plan’. Rick Betancourt and Andrew Hollingsworth are both CFPs and CPA enrolled agents. I have no interest in retiring, however; it makes sense for me to bring in younger people now so that my clients, friends and potential future clients can get to know them and feel comfortable with their knowledge and experience for the day when I may not be here for you.
As an introduction, I have asked Andrew to put together an article on the new Qualified Business Income (QBI) deduction which will affect many smaller businesses going forward. Please read the Article and if it pertains to you speak with your CPA or call Andrew and/or Rick to discuss the details of this and other new tax laws – as follows:
"With the April 15 tax filing deadline (or in this year's case, April 17) now come and gone, it may seem like an inopportune time to discuss taxes, since many people tend to only think about this rather unpleasant topic when their W-2s and 1099s start rolling in every January. However, tax planning can and should be a year-round practice, and this is especially true with the passing of the Tax Cuts and Jobs Act of 2017 last December, which enacted the most comprehensive tax legislation overhaul since the mid-1980's. While much of the press over this new law had been on individual income taxes, the focus of this article will be on the business side of things, as there is one new deduction available to many small business that could have a major impact on their tax burden, namely, the Qualified Business Income (QBI) deduction.
This new deduction allows businesses (other than C-corporations) to take a deduction of up to 20% of the "qualified business income" of the business on the owner's personal tax return. In essence, after the business has calculated its net income as it normally would, the QBI deduction allows the business to take an additional deduction of up to 20% of that number before arriving at taxable income. The deduction is available to sole proprietors who file Schedule C, S-corporations, and partnerships and LLCs who file as partnerships on federal form 1065. A free 20% deduction on top of the all the normal business deductions sure sounds great - and make no mistake, it is - but like all tax legislation, it's not quite that simple, and several key aspects are still awaiting IRS guidance on how the new law will be applied. There are also a host of rules and potential income phase outs that apply, and this is where the tax planning aspect comes in. If you are a small business owner, you must be aware of the QBI deduction and how to take advantage of it, as it could potentially save you a significant amount in federal taxes.
The first limitation of the QBI deduction is the W-2 wage limitation. The deduction is limited to 50% of the total wages paid by the business. However, this limitation does not apply if the total taxable income of the business owner is less than $315,000 for married filing joint return (MFJ) or $157,500 for all others; if income exceeds these levels, the limitation phases-in until it applies in full at $415,000 (MFJ) and $207,500 (all others).
The second limitation of the QBI deduction is the qualified property limitation. The deduction can also be limited by the sum of 25% of the W-2 wages, plus 2.5% of the basis of all qualified property (generally, depreciable property), but this limitation is complex and beyond the scope of this article. What is more pertinent to many readers is a rather large exclusion of certain types of businesses: "specified service businesses" are specifically excluded from taking the QBI deduction, and include those involving the performance of services in the fields of law, accounting, financial services, and other fields where the reputation or skill of the owner or employee(s) is the principal business asset.
However, to those attorneys and CPAs reading this article, all hope is not lost! If your taxable income falls under the thresholds mentioned above ($315,000 MFJ and $157,500 (all others), the specified service business exclusion does not apply, and you are free to take full advantage of the QBI deduction, subject to the other limitations discussed above. The QBI deduction is then phased out at the same levels as the W-2 limitation phases in, and is reduced to zero at $415,000 (MFJ) and $207,500 (all others).
There are several other important aspects of this deduction, but for planning purposes, it is important to understand what businesses qualify to take advantage of the deduction, and at what income levels phase-outs or limitations start to kick in. If you are a small business owner who may qualify for this deduction, I recommend you consult with your accountant well before the end of the year. There may be certain steps to take ahead of tax time in order to qualify for the QBI deduction, and proper planning could mean the difference between next year's filing season being bearable - or a lot more unpleasant than usual."
As always, thank you for reading our articles and please feel free to call us with any questions that might come up. We are here to assist you in your quest for a comfortable retirement.