With the tax filing deadline approaching, now is an excellent time for small businesses to assess their financial situation. Besides, make plans to maximize the value of the Section 199A Qualified Business Income or QBI deduction.
For most personal and small company clients, 2020 and 2021 have been tumultuous. However, many small businesses have neglected simple tax planning strategies that might help them take advantage of the Section 199A QBI deduction.
It’s not too late to take action and reduce taxable income and qualify for the full 20% QBI deduction. Some of these strategies can provide substantial long-term advantages and maximize the QBI -Exceed deduction.
The TCJA established the Qualified Business Revenue or QBI deduction in 2017. It allows pass-through entrepreneurs to deduct up to 20% of their share of taxable income – subject to a slew of regulations and limitations.
For instance, if their income is too high, certain Service Section Trades or Businesses (SSTB) owners lose the deduction. SSTBs are any service-based business that relies on the reputation or expertise of its workers or owners.
Some SSTBs include:
* Law companies
* Doctor’s offices
* Consulting businesses
* Professional athletes
* Performing artists
* Accountants and financial advisors
* Investment managers
Once your total taxable income surpasses a particular level, your QBI deduction will begin to phase down if your firm is an SSTB. These thresholds are $164,900 for solo filers and $329,800 for married couples filing jointly for the 2021/2022 tax year. It would be best to compute your deduction using Part II of Form 8995-A. However, you cannot claim the deduction if your income exceeds $214,900 for single persons ($429,800 for jointly filed couples).
If your firm isn’t an SSTB, but your total taxable income exceeds these thresholds, you can still claim the deduction, but it’ll be restricted to:
* 50% of your share of W-2 wages paid by the company
* 25% of these earnings plus 2.5 percent of your part of eligible assets
Confused? You’re not the only one who feels this way. The QBI deduction may be a valuable tax break for small businesses. But determining who qualifies and computing the deduction can be complex. If you believe you are eligible, talk to your CPA firm.
If a firm has both service and non-service revenue, dividing the business into two independent businesses will allow the non-service income to qualify for the 20% deduction. Although it’s not always evident if more than one entity exists, the IRS may take into account the following four factors:
* Whether distinct legal entities run the firms
* Whether the enterprises keep separate books and records
* Customers, workers, and management who overlap
* The volume of transactions between organizations, as well as other interdependencies
For example, an eye clinic can work with its CPA firm to build a method for separating accounting for revenue and costs associated with optometric services and the sale of eyeglasses in order to be eligible for the 20% deduction. In this case, splitting the clinic into two firms can allow taxable income from the glasses portion to qualify for the 20% deduction.
Careful year-end tax preparation can help you stay below the income level ($164,900 for solo filers and $329,800) and take advantage of the 20% deduction.
Any of the standard year-end income reduction measures should work, such as:
* Contribute to a retirement plan
* Defer income
* or Accelerate deductions
For example, Frank is married and owns a sole proprietorship legal practice that uses cash to record revenue. Frank and his wife anticipate a taxable income of $450,000 in 2021/2022. Frank follows his accountant’s advice, contributes a significant amount to his retirement funds, pays off all of his debts, and takes other proactive planning actions, lowering his taxable income to $300,000. As a result of the change, Frank may now claim the 20% deduction.
If the deduction amount is restricted by the amount of W-2 wages received, there may be ways to enhance the amount by changing business operations. Consider the following suggestions:
* When employees supply services to linked firms, review the intra-group allocation of labor expenses. If an employee of one firm performs services for another affiliated company, make sure the person’s compensation is split evenly between the two companies.
* Where financially possible, consider recruiting personnel to do work done by external vendors.
* If required, raise owner pay to put them in line with market remuneration.
Before making a decision, keep in mind that there are various additional aspects to consider.
Changing a salary without an underlying change in facts, such as a change in duties, scope of work, or other factors, might lead to the IRS challenging the salary level paid in previous years as being unreasonably low. This can result in backpay payroll taxes and penalties. Before making any changes to your salary, talk to your CPA to make sure you’re aware of possible repercussions.
A competent tax advisor’s value lies in finding tax savings potential for their clients, and QBI is a great place to start! While the best time to plan for taxes was towards the end of the year, there’s still time to lower your small company’s taxes.
While the tax reform simplified several areas of the tax system, one of them is the company tax deduction. Foster Financial CPA will help you get the most out of tax reform by working with you to put desired strategies in place, such as the ones outlined here. This will maximize your company income deductions in a way that’s right for you. Contact our licensed tax experts at Foster Financial CPA, and schedule an appointment.
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