As you likely know by now, the Tax Cuts and Jobs Act created a 20 percent tax deduction under new tax code Section 199A.
The question for you: Will you reap any benefits from this new deduction?
And the second question: If your qualifying for the 20 percent tax deduction looks bleak, what can you do now to create some hope for the deduction?
Let me be clear—we are here to help.
If your defined taxable income is $315,000 or less (joint return) or $157,500 or less (single), you can relax. You don’t need any strategies to realize your Section 199A deduction. It is simply the lesser of 20 percent of your taxable income (less net capital gains) or 20 percent of your qualified business income.
Example. John is single, a lawyer, with $125,000 in qualified business income and $150,000 in taxable income (excluding net capital gains). John’s Section 199A tax deduction is $25,000 (20 percent x $125,000).
Once you exceed the $315,000 (married) or $157,500 (single), we should spend at least a few minutes reviewing your deduction.
Here’s an example of why this is important. We just reviewed a return that would have had $315,001 in taxable income and $350,000 in qualified business income. With that income, the 199A deduction was zero for this individual, but with $1 less in taxable income, this individual’s deduction is $63,000. We are helping this individual avoid that highly troubling $1 so he can realize his $63,000 deduction.
If you expect to exceed the thresholds, we should talk, because some planning ideas require that you have time on your side. Also, once the year is over, you have very few, if any, Section 199A planning opportunities.
Strategies to Consider
Now that you know how the calculator works, you can see firsthand if you have a problem and then see if the
strategies you have in mind will produce the deduction you want. To give you a head start on this year, consider the
following possibilities:
Strategy 1. None
If your defined taxable income is $315,000 or less (joint return) or $157,500 or less (single), you can relax. You
don’t need any strategies to realize your Section 199A deduction. It is simply the lesser of 20 percent of your
taxable income (less net capital gains) or 20 percent of your qualified business income.
Example. John is single, a lawyer, with $125,000 in qualified business income and $150,000 in taxable income
(excluding net capital gains). John’s Section 199A tax deduction is $25,000 (20 percent x $125,000).
Strategy 2. Self-Employed Taxpayer Becomes S Corporation
Situation. Harry is self-employed, in the in-favor group, single, with taxable income of $400,000 and qualified
business income of $370,000. With no wages or property, Harry’s Section 199A deduction is zero.
Solution. Harry changes his business structure to become an S corporation and has his S corporation pay him
$100,000 in wages. With the wages, Henry’s taxable income is still $400,000, his qualified business income is now
$270,000, the wages are $100,000, and Harry’s Section 199A deduction is $50,000 (50 percent x $100,000).
Bonus money. Harry also saves $10,834 in self-employment taxes.
Note how important tax planning is to Harry. With no (or too little, too late) tax planning, Harry gets a zero Section
199A deduction and pays a lot of self-employment taxes.
By getting his S corporation in place today, Harry can obtain the $50,000 deduction and also save a bundle on his
self-employment taxes.
For you, note to self: plan now—don’t wait.
Strategy 3. Cut Your S Corporation Salary
Situation. Fred operates his business as an S corporation. He takes a $128,000 salary. The S corporation
generates $132,000 of qualified business income. Fred is married, and the couple has defined taxable income of
$300,000. Fred’s Section 199A deduction is $26,400.
Solution. Much improved. Fred learns how to prove that a $68,000 salary is reasonable. This gives Fred three benefits:
- The lower salary increases the S corporation’s qualified business income to $196,590 ($132,000 +
$60,000 + $4,5907). Now, Fred’s Section 199A deduction is $39,318 (a $12,918 increase). - The $60,000 in reduced salary takes $4,590 of personal FICA taxes away from the government and
puts that money in Fred’s pocket. - The $60,000 in reduced salary also reduces the S corporation’s FICA taxes by $4,590, which
increases the corporation’s passthrough income to Fred. On the $4,590 from the corporation, Fred
pays an additional $1,102 in taxes. Net result: Fred puts another $3,488 ($4,590 – $1,102) in his pocket.
Strategy 4. Spin Off a Tax-Favored Business
If your business is currently in the out-of-favor group, but it has some in-favor business possibilities, you might spin
off the in-favor business.
Situation. Ed is an ophthalmologist who generates 20 percent of his $1 million business income from his eyeglass
business, which operates in the waiting room of his medical practice. Perhaps when we see IRS regulations in the
next six months, year, two years, three years, or whenever, this eyeglass business will count as a separate
business. Based on what we know at the moment, it’s possible that Fred gets a zero Section 199A deduction,
because he possibly earns all his high income from one out-of-favor business.
Solution. Ed creates a new proprietorship to house the eyeglass business. This creates a $40,000 Section 199A
deduction for Fred from an in-favor business ($200,000 x 20 percent).
Strategy 5. Create or Enhance Your Retirement Plan
Situation. You are married, in an out-of-favor business, with no W-2 wages or property, and taxable income of
$365,000. Your Section 199A deduction is zero.
Solution. Create a retirement plan that allows you a business deduction of $50,000 or more so that you can drive
your taxable income down to $315,000 or lower. Let’s say you did that and that your qualified business income is
now $335,000 and your taxable income is $315,000. Your Section 199A tax deduction is $63,000.
Bad Strategy Ideas And Takeaways
This brings us to what we think are bad strategy ideas that you see floating about. We are going to tell you not to
do these things and why we think that:
Be careful converting Independent Contractors to employees. Lots of reasons to not do this that may outweigh doing this long term.
Don’t get married just for tax deductions. You have many good reasons to get married, but the Section 199A deduction is not one of them.
Not knowing your numbers until AFTER year-end. If your defined taxable income will be $315,000 or less (married, filing jointly) or $157,500 or less (single), you have no Section 199A tax planning to do. You qualify for the 20 percent deduction on your qualified business income—period.
Call us you want to sit down and talk YOUR numbers. We always offer free consultations.