Utilizing the Qualified Business Income Tax Deduction
Along with a lower corporate tax rate (21 percent), the Tax Cuts and Jobs Act of 2017 developed a Qualified Business Income (QBI) tax deduction for specified trades and businesses that are pass-through entities (i.e., sole proprietors, S corporation shareholders and partnerships). This provision allows taxpayers to deduct as much as 20 percent of their pass-through income on their personal tax return.
First, the bad news: Dentists are NOT one of these specified trades or businesses. Dentists, along with accountants and financial advisors, are subject to a specified service limitation that makes them ineligible for the QBI deduction.
But, there is good news: The specified service limitation does not apply for dentists whose personal taxable income is less than $315,000 (married filing jointly) or $157,500 (filing single). In other words, a dentist may still qualify for the 20 percent QBI deduction.
How might this work? Let’s look at some hypotheticals (created for illustrative purposes only).
Example 1: Dr. Smith is a 50 percent partner in a practice that generated $400,000 in net profits last year (of which Dr. Smith received his $200,000 share). In addition, Dr. Smith’s wife, Jennifer, makes a $100,000 salary. The couple has a portfolio that cumulatively generated about $20,000 of interest and dividends in the past year. As a result, their combined Adjusted Gross Income is $320,000. Because they don’t own a home (and thus can’t take the mortgage interest deduction) and their other deductions are limited, they simply claim the $24,000 standard deduction, which reduces their tentative taxable income to $296,000.
Because their income is less than the $315,000 threshold, Dr. Smith is eligible for a $40,000 QBI deduction ($200,000 x 20 percent). As a result, their taxable income is $256,000 ($296,000 – $40,000).
Does this mean that if your tentative taxable income is greater than the threshold you will not get this deduction? Not necessarily. The QBI deduction phases out over the next $100,000 of income ($415,000 married filing jointly and $257,500 filing single).
Example 2: Same facts as Example 1, except Dr. Smith’s share of profits is $270,000. As a result, his and his wife’s combined Adjusted Gross Income is $390,000 and their tentative taxable income rises to $366,000. Without the restrictions, Dr. Smith would be eligible for a QBI deduction of $54,000 (20 percent of $270,000). But because the couple’s now larger tentative taxable income takes them 51 percent of the way through the $100,000 phase out, the QBI deduction is limited to $26,460 (49 percent of $54,000). As a result, their taxable income is $339,540 ($366,000 – $26,460).
Importantly, pass-through entity dentists can use a number of tax-planning opportunities to still qualify for the full QBI deduction.
Example 3: Same facts as Example 2, but assume Dr. Smith maximizes his 401(k) contribution (in this case, $55,000) in 2018. His share of the profits drops from $270,000 to $215,000, and his tentative taxable income falls to $312,000. As a result, Dr. Smith qualifies for the full QBI deduction of $54,000 and the couple’s taxable income is reduced to $258,000 ($312,000 – $54,000).
Please understand that income tax planning is best accomplished with the help of your CPA and attorney. As they say on television, don’t try this at home!
Strongly consider contacting your CPA so you can review your eligibility for the QBI deduction. There are potentially a number of tax-planning opportunities you can still take advantage of this year, but you need the time to plan.
This commentary originally appeared October 10 on DentalTown.com
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