Small business owners may not realize the tax law change in 2017 created a tremendous opportunity for them to save thousands of tax dollars. The law created IRC Section 199A, which allows for the Qualified Business Income (QBI) deduction. This deduction applies to pass-through businesses that are not set up as C-corporations (e.g., sole proprietors, partnerships, S-corps). These pass-through businesses can now deduct 20% of QBI within certain limitations.
Most business owners and their CPAs know about the QBI deduction, but they don’t know about the additional benefit of coupling the deduction with the right retirement plan. Using a retirement plan can qualify a pass-through business for the 20% deduction that otherwise might not have been eligible. Also, contributing to a retirement plan can increase the QBI deduction amount a small business owner can take.
Let’s look at an example of what is called a “super deduction”. As a partner in a law practice, Mary is considered part of a specified service trade or business (SSTB) and her income limits her ability to take advantage of the QBI deduction. She makes $415,000, $100,000 more than the allowable amount to use the deduction as a SSTB. If she can contribute $100K to a retirement plan, she lowers her taxable income to the QBI threshold of $315K. This allows her to fully utilize the 20% QBI deduction, resulting in a $163,000 total deduction ($100K retirement & $63K QBI deductions). This strategy saves Mary near $50,000 in Federal Taxes, a significant sum.
Every person’s tax situation is different. Always talk your tax accountant before implementing any strategy that could impact your taxes. But if your situation is right, working with your CPA and a Retirement Specialist could save you significant tax dollars.