Maximizing QBI Deduction

By Terry Westlund, Co-Founder

Remember the big hub-bub about tax reform almost a year ago? Although the new tax rules were announced at the end of 2017, they don’t take effect until you start working on your 2018 return. Therefore, many are just now starting to think about the changes. The good news? If you are a 1099 provider, you may have an opportunity to save thousands in taxes with the new Quarterly Business Income (QBI) deduction – also known as the “20% pass-through”. Before the new tax rules were finalized, there was question around whether medical professionals would be able to take advantage of this new rule. Just to be clear, this 20% pass through DOES apply to 1099 medical professionals… if you qualify….

So How Do I Qualify?

Before I answer that question, it’s important to be clear on how to calculate TAXABLE INCOME. Taxable income is simply your income minus any deductions or exemptions allowed in the tax year.

For married individuals, the goal is to reduce your taxable income to $315,000 to get the full benefit of this new tax rule. At this point you can apply a 20% deduction… $315,000 x 20% = $63,000. At a 24% tax rate, that saves $15,120 in taxes! Not too shabby. Does $315,000 seem like an impossible number to achieve? Ask your financial advisor about Defined Benefit Plans. If implemented appropriately, these kinds of plans can allow you to save upwards of $100,000 for retirement and therefore further reduce your taxable income.

If your taxable income is between $315,000 and $415,000 (for married filing jointly), you can still save on taxes through the phase-out portion of the new pass through rule (“dollar for dollar”). For single taxpayers, the taxable income limits phase out from $157,500 to $207,500.

Don’t forget as an independent contractor, you have many ways to lower your taxable income including deducting health insurance premiums, HSA contributions, 50% of social security & Medicare tax, retirement contributions (up to $55,000 in 2018 or $61,000 for individuals age 50+… more with a DBP as described above) and deductible business expenses. Historically retirement contributions were typically one of the largest deductions you can make. Now the QBI deduction has the potential to be an even greater deduction.

20% Pass-Through Deduction Example

Sometimes it is easier to explain tax rules with an example. John Doe, MD, an emergency physician, is married and has $440,000 of I.C. income. Here is how he will utilize this deduction:

Business Income

$440,000

Deductible Business Expenses

($16,000)

Net Business Income

$424,000

50% of S.S. & Medicare Tax

($13,500)

Health Insurance and HSA Contributions

($16,500)

Individual 401(k) Contribution

($55,000)

Standard Deduction

($24,000)

Taxable Income

$315,000

QBI Deduction

($63,000)

Net Taxable Income

$252,000

At a 24% tax rate, Dr. Doe will be saving approximately $15,000 in taxes by utilizing the new QBI deduction. Now that’s worth paying attention to!

What if my spouse generates W-2 income?

Technically the deduction is calculated from whichever is lower… your “Net Business Income” or your “Taxable Income”. If you only have 1099 income, your “Taxable Income” is usually the lower amount. If you have W-2 income to also account for, you may find yourself taking 20% of your “Net Business Income” as it may be the lower of the two. Here is an example: Ron has $300,000 of independent contractor income and his spouse makes $135,000 in W-2 wages:

Business Income

$300,000

Deductible Business Expenses

($15,000)

Net Business Income

$285,000

50% of S.S. & Medicare Tax

($10,000)

Health Insurance and HSA Contributions

($15,000)

Individual 401(k) Contribution

($61,000)

Standard Deduction

($24,000)

Spouse W-2 Income

$135,000

Taxable Income

$310,000

QBI Deduction

($57,000)

Net Taxable Income

$253,000

The pass through is calculated from the “Net Business Income” as it is lower than the “Taxable Income”, resulting in a deduction of $57,000 ($285,000*20%). This is still about a $14,000 savings in tax at a 24% tax rate!

Any other considerations I should be aware of?

Historically we recommended medical professionals making over $330,000 should consider forming an S-Corp to save more in taxes. With the new QBI deduction, work with your CPA to determine if the way your S-Corp is set-up truly maximizes your tax savings. You may need to make an adjustment to your flow-through income or consider dissolving the S Corp to take full advantage of the QBI deduction. For more information on entity formation, see one of our blog entries here.

For more details on how this deduction might work within your tax strategy, contact your tax professional or our experienced team. You can reach us at 888-898-3627 or make an appointment here: https://www.appointmentcore.com/app/freeslots/KpvdtvV

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