What is the 20% QBI Tax Deduction?
In the tax world – and at Robert P. Russo, CPA – everyone is talking about QBI. QBI stands for qualified business income, and it’s the key to unlocking a very nice 20% QBI tax deduction for certain business owners.
The 20% QBI tax deduction is outlined in section 199A of the Tax Cuts and Jobs (TCJA) Act, signed into law in December 2017. Like many of the rules in the TCJA, section 199A continues to pose both challenges and opportunities for taxpayers. Here’s what you need to know…
Who Can Take the 20% QBI Tax Deduction?
The 20% QBI tax deduction is limited to “pass through” business entities (after all it’s qualified “business” income) in specified service industries. Let’s break this down:
Pass Through Entities: A pass-through entity is a business structure where the income “passes through” to the owner, who then takes the income on their personal return. This includes:
- Sole proprietors and LLCs
- S Corporations
Specified Service Industries: This includes everything from lawyers to accountants, doctors to graphic designers. The IRS says it’s anyone whose principle asset is the skill of the owner of its employees. This is very complex, and it’s important to check with a CPA first to decide if you fall into a specified service industry or not.
Great! I’m a Lawyer Set Up as an LLC, Making About $250,000 a Year – So I get about a $50,000 Deduction? Awesome.
Sorry to burst your bubble, but the IRS set limitations on the 20% QBI tax deduction. Once you reach the lower end of the thresholds noted below, your QBI tax deduction is incrementally reduced. Once you reach the high end of the spectrum? You are no longer eligible for ANY QBI.
Filing Single: $160,700-$210,700
Married Filing Jointly: $321,000-$421,000
Filing Single: $163,300-$213,300
Married Filing Jointly: $326,600-$426,600
What? I am Losing Out on Thousands in Tax Savings?
There’s still hope. First, if you are NOT a specified service business, The IRS states you can take the lesser of these two deductions:
- The 20% QBI tax deduction, OR
- The greater of (50% of W2 wages paid through your business) or (25% of the wages plus 2.5% of qualified property).
By paying wages, you reduce your QBI – and might then be able to take that 20% deduction, or at least deduct paid wages.
Ok, Tell Me How I Can Get the 20% QBI Tax Deduction in 2019 and 2020!
If you are on the verge of losing out on the QBI tax deduction, here are 5 ways to preserve it.
1) Turn Independent Contractors into Employees
Now might be the time to talk to your contractors. Yes, you will need to pay 7% in payroll taxes – but if it means you’re able to take a 20% tax deduction – it might be worth it.
2) Employ Your Children…
Are you paying your 12-year-old an allowance? Could she instead be paid wages for helping you with office work? There are many tax advantages to employing your own children. There are no age limitations (although asking a toddler to file reports probably won’t work). Paying your kids is a great way to reduce your QBI and potentially take the 20% QBI tax deduction.
3) …or, Employ Your Spouse!
Consider paying your spouse a salary or wages for assisting you with your business. Yes, this may help you preserve the 20% QBI tax deduction.
4) Set Up an S-Corp and Pay Yourself a Salary
Unlike an LLC, an S-Corp allows you to pay yourself a salary. Setting up an S-Corp is an involved process but it may be worth it so you can take the 20% QBI tax deduction. Learn about creating an S-Corp, here.
Now, only the QBI recorded after you set up the S-Corp will be reduced by your new salary. It is not retroactive. Still, it may be a good move to make. Here’s how it works:
- If your profit is $200,000, you can pay yourself a reasonable salary of $70,000 (and pay about $5,000 in payroll taxes).
- Your profit (or QBI) is now $125,000. So, 20% of $125,000 is $25,000. But your total taxable income is $182,200 ($200,000 profit less the $5,000 in payroll taxes and the $12,200 standard deduction).
- $182,200 is in the “phaseout” zone for 2019 (above $160,700 but below $210,700) – and you should consult with a CPA to determine how much of a deduction you can take.
- But remember, the IRS says you must take the LESSER of (20% of QBI or 50% of salary – less the phaseout percentage) OR the lesser of 1 or the taxable income. Yes, it’s a complicated calculation. This is when hiring an NYC accountant is a good idea!
5) Create a Separate, Capital Intensive Business
Another strategy to ensure you can take the 20% QBI tax deduction is to move income to a separate entity. For example, you could set up a law practice management company that handles your billing, HR, payroll, and general office management. It is not clear yet if the IRS would allow this, check with us first before moving ahead.
At the end of the day, the 20% QBI tax deduction is complicated for the average business owner. All of us at Robert P. Russo CPA are always ready to help you maximize your deductions!
Contact us today so we can strategize ways for you to maximize your tax savings. Otherwise, you could miss out on thousands in tax savings.