The 2017 Tax Cuts and Jobs Act established the qualified business income deduction, which allows a deduction of up to 20% of qualified business income from a trade or business that is operated as a sole proprietorship, partnership, S-corporation, trust, or estate. This deduction is available for tax years beginning after December 31, 2017, and ending before January 1, 2026. The qualified business income deduction calculation can be complicated and cumbersome, and your deduction may be limited if your taxable income exceeds certain thresholds. The thresholds for the 2019 tax year are $321,400 for married filing joint; $160,725 for married filing separate; and $160,700 for single and head of household.
If the qualified business income is generated from a specified service trade or business and total taxable income exceeds the above-mentioned thresholds, no qualified business income deduction is available. However, if the qualified income generated is from a trade or business that is not a specified service business, there are additional thresholds and calculations to determine the amount of the qualified business income deduction that you are allowed. A specified service trade or business is defined as “any trade or business involving the performance of services in the field of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.” Excluded from this definition are architecture and engineering businesses.
If your taxable income will exceed the threshold, you should consider alternate planning strategies to reduce your taxable income which may allow you to receive some benefit from the qualified business income deduction.
The following are planning ideas that may be utilized to reduce taxable income:
- Reduce taxable bonds with tax free bonds
- Invest in life insurance & annuities for tax deferral of income
- Real estate investments
- Oil & gas investments
- Recognize losses
- Accelerate charitable contributions
- Pension plan contributions
- Increase payroll expenditures
- Accelerate business expenses
- Cost segregation studies
- Captive insurance companies
- Broaden ownership group of pass-through entities to those with lower taxable income
- Gifts to taxpayers with lower taxable income (children, trusts)
If your taxable income is below the taxable income threshold amount, there are some planning opportunities to increase taxable income from the qualified trade or business, which would allow you to increase the amount of your qualified business income deduction.
- Defer business expenses
- Defer acquisitions of new property eligible for section 179 or bonus depreciation; elect out of Section 179 and bonus depreciation on asset additions
- Reduce wages paid
- Reduce leverage to reduce interest expense
When taxable income exceeds the thresholds for a non-specified service trade or business, the qualified business income deduction calculation is the lesser of:
- 20% of qualified income from the trade or business, or
- The greater of 50% of the total W-2 wages from the business, or
- 25% of the total W-2 wages from the business plus 2.5% of the unadjusted basis of qualified property of the business
A few planning strategies to increase these amounts are:
- Acquire or improve qualified property prior to year end
- Carefully consider whether items are capitalized or expensed
- Understand what property will “roll off” at year end
- Employee bonuses
- S Corporation election for owner wages
- Review and compute effectiveness of the aggregation of related businesses
If your trade or business is a real estate entity, safe harbor rules have been released which will allow real estate businesses to take advantage of the qualified business income deduction. A real estate trade or business will be considered a qualified trade or business if:
- Separate books and records are maintained for each rental activity
- 250 or more hours of rental services are performed or overseen throughout the year
- Maintain records of all services performed, who performed services, and dates & hours of the services performed
Rental real estate entities can elect to treat multiple rentals as one entity in order to meet the safe harbor rules, but you cannot mix commercial and residential properties for this election. Triple net leases and real estate used as a residence of the taxpayer do not qualify.
Every business and individual should be proactive and plan ahead in order to find opportunities to fully maximize their allowable qualified business income deduction. Now is the time to implement relevant strategies and tax planning ideas. If you have questions on how this deduction impacts you and your business, please contact RDG+Partners to request a review of your individual situation