The new 20% tax deduction for qualified business income (QBI) provides valuable tax savings for many pass-through business entities—except for those categorized as “service businesses” with income that exceeds certain threshold levels.
Service business owners who earn too much may miss out on the 20% QBI deduction entirely if they earn above the applicable thresholds.
Fortunately, planning strategies have already emerged to allow these business owners to reap the benefits of the new deduction. Using non-grantor trusts can help service business owners sidestep the income restrictions to potentially take full advantage of the QBI deduction—but because future IRS guidance on the application of new Section 199A is expected, business owners must, of course, exercise caution.
The QBI Deduction
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The 2017 tax reform legislation now allows pass-through entities (including partnerships, S corporations and sole proprietorships) to deduct 20% of QBI (in 2018-2025, unless Congress takes steps to extend the deduction). However, service businesses (including attorneys, accountants, doctors and financial advisors) are not entitled to the full benefit of the 20%deduction if the business owner’s taxable income exceeds certain threshold amounts.
The applicable threshold levels for 2018 are $315,500 (married filing jointly) or $157,500 (single filers), and the deduction is phased out for service business owners with income between the threshold levels plus $50,000 for individual filers or $100,000 for joint filers. This means that clients who own service businesses and have taxable income that exceeds $415,000 (married filing jointly) or $207,500 (single filers) will not receive the benefit of the new deduction.
Many expect that the IRS will release additional guidance on what exactly constitutes a service business, but in the meantime, small business clients who may be categorized as such should be advised of potential planning strategies to consider in order to qualify for all or a part of the QBI deduction.