The Tax Cuts and Jobs Act of 2017 has not changed ever since it was enacted as one of the landmark legislative actions of the Trump administration. One of the most interesting aspects of this business-friendly tax legislation can be found in Section 199A, which is better known as the Qualified Business Income tax deduction. This section of the law, which as of 2022 will still be in effect for three more years, can benefit taxpayers who are either business owners or generate self-employment revenue. 

Business Income Deduction

How The Qualified Business Income (QBI) Deduction Works

Right off the bat, you should know that Section 199A was drafted with net taxable income in mind. This is important to know because gross income is routinely mentioned in business accounting, but QBI is based on the income calculated when you subtract allowable deductions from gross revenue, and this is a major reason why you should retain a tax accounting firm to figure this out. Section 199A is certainly a tax advantage you will want to maximize when filing, which means paying close attention to everything that may qualify. 

Eligible taxpayers are those who derive income through business ownership. A sole proprietorship would be eligible, and the same goes for S-corps, limited liability companies, partnerships, and even trusts in some circumstances. Self-employed professionals such as physicians would also be eligible, but they may be classified within the service business segment, which means that they fall under a different QBI threshold. Since this tax cut was designed to be valuable for owners of small businesses, the basic QBI threshold for 2021 is as follows:

* $164,900 if your taxpayer status is single.

* $329,800 if your status is married filing jointly.

If your 2021 QBI calculation comes under the dollar amounts above, you may qualify for a full deduction of up to 20% on the taxes you owe. You should not feel excluded if you go over; you may still qualify for a partial deduction that would be less than 20%, but this will add a layer of complexity to your tax returns.

We can now talk about self-employed providers of professional services who often do business as sole proprietors. The thresholds are a bit different for physicians, actors, lawyers, athletes, and many other professionals who fall under the specified service provision of IRS Publication 535:

* $214,900 for those filing as single taxpayers.

* $429,800 for those who are married filing jointly.

Once you go over these amounts, it does not make sense to pursue this deduction. What makes sense is working with a tax accounting professional to reduce taxable income so that it falls below the threshold; for many taxpayers, this could be easier than dealing with IRS intricacies related to the partial QBI deduction. You really want to strive for that full 20% deduction, and one way to do so may involve annual contributions to retirement plans.

QBI and Individual Retirement Plans

The Simplified Employee Pension IRA and individual 401(k) plans are two financial strategies you can use to lower your taxable income below the threshold needed to claim the full QBI deduction. It is possible to make strategic contributions to these plans so that they serve the twofold purpose of funding your retirement and saving as much as possible on your annual tax return. 

With a SEP-IRA, a married couple who are in business together could make a contribution up to $58,000 each, thus making a substantial reduction to your annual taxable income. This also works for taxpayers with single filing status. You may still have time to set up a SEP-IRA in 2022 and reflect the contribution towards your 2021 tax return, but this has to be done prior to the filing deadline.

A similar scenario applies to Solo 401(k) plans, with the added advantage that they allow you to make contributions as the employer and employee; this could work nicely if you are on the payroll of the business you own and operate. The way this retirement plan is structured, a business owner who is also an employee over the age of 50 could make a $64,500 contribution in 2021 for the purpose of lowering taxable income. 
Want to learn more about QBI deductions and other tax advantages available to you for the 2021 and 2022 filing periods? Contact WKB Accounting today so that we can discuss your options.