The IRS recently published final regulations regarding Section 199A of the Internal Revenue Code. That section, created by the Tax Cuts and Jobs Act of 2017, offers a 20% deduction for qualified business income (QBI). This deduction may be available to non-C-corporation taxpayers such as sole proprietors, business partners, certain LLC members, S corporation shareholders, and some others reporting business income.
Taxable income affects the ability to take the QBI deduction. The annual thresholds, which are indexed for inflation, are taxable income of $321,400 on joint returns in 2019, $160,725 for married individuals filing separately, and $160,700 for single taxpayers as well as heads of household.
If your taxable income is below those thresholds, taking the QBI deduction might be relatively simple. You would calculate your QBI and possibly deduct 20%.
With taxable income above the thresholds, however, limitations arise. One limitation is based on a formula involving employee wages or the taxpayer’s unadjusted basis in qualified property, or both; the other limitation applies to specified service trades or business, an extensive list ranging from accounting to trading securities. In any case, reducing taxable income that’s over the threshold may permit a larger QBI deduction.
Contributing to a retirement plan can reduce taxable income. However, the final regulations confirm that a pretax deduction for retirement plan contributions is included in the calculation of QBI. Therefore, reducing taxable income also may reduce the QBI deduction. If possible, it’s better to avoid this offset.
Our office can go over the numbers with you to project the tax savings from such maneuvering to affect QBI. In general, the more years you’ll have until required minimum distributions start after age 70½, the greater the advantage of increasing contributions to tax-deferred retirement accounts.