These strategies will help you get the most out of the 20% QBI deduction
First active in 2018, the qualified business income (QBI) deduction gives eligible taxpayers an additional 20% deduction off of their net income from qualifying income. This is a significant amount, so it’s crucial to understand how it works, what qualified income is, and how you can maximize the deduction as a physician.
In this blog, we walk through:
- QBI basics
- The phase-in and phase-out of the QBI deduction
- 10 strategies to maximize your QBI deduction
The QBI basics
This 20% deduction encompasses QBI, qualified REIT dividends, and publicly-traded partnership income. However, it doesn’t include a lot of other income types, like:
- Dividends, investment interest income, capital gains, annuity income, etc.
- Reasonable compensation paid by an S corporation to a shareholder
- Guaranteed payments made to a partner of a partnership
- Amounts allocated or distributed by a partnership to a partner for services rendered to the partnership
So, who qualifies?
- S corporation and partnership owners
- Sole proprietors
- Certain trusts and estates
What is considered qualified income? QBI is the net income, gain, deduction, and loss with respect to any trade or business, as long as it is not:
- A Specified Service Trade or Business (SSTB):
- It involves health, law, consulting, athletics, financial, and brokerage services;
- The reputation or skill of the owner or employers is its principal asset; or
- It involves investing and investment management trading, securities, partnership interests, or commodities.
- A trade or business performing services as an employee. (i.e., if you are a W-2 employee, you cannot take the QBI deduction.)
The phase-in and phase-out of the QBI deduction
Another important thing to know: For businesses that are not SSTBs, the 20% QBI deduction is subject to phase-out in 2020 for taxable income at the following amounts:
- $326,600 if married filing jointly
- $163,300 if you are a single filer
If your income is over these amounts, the deduction is the lesser of:
- 20% of QBI, or
- 50% of W-2 wages, or
- 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property
If the business is an SSTB, the 20% QBI deduction is subject to a 2020 phase-out for the taxable income of the following:
- $326,600 if married filing jointly
- $163,300 if you are a single filer
However, if taxable income exceeds these amounts, then the QBI is zero:
- $426,600 if married filing jointly
- $213,300 if you are a single filer
10 strategies to maximize the QBI deduction
Now let’s dive into 10 strategies to make the most of the QBI deduction.
1. 1099 Schedule C becomes an S corporation
Say you’re married filing jointly, and your physician income is $450,000. Your taxable income is $400,000, and the QBI deduction is $6,368. If you change your structure to become an S corporation, however, and pay yourself a salary of $225,000, your QBI deduction will be boosted to $11,970.
You’re also saving on self-employment tax if you become an S corporation.
2. Cut your S corporation salary
In this case, instead of paying yourself $225,000 as in the example above, say you reduce that salary to $150,000. With these wages, your QBI deduction will be $15,960, and you saved over $2,000 on FICA and Medicare taxes.
3. Spin off a tax-favored business
Another example: say you’re an ophthalmologist generating 20% of your $1 million income (which is taxed as an S corporation) from the eyeglass portion of your business that operates in your waiting area. Your QBI deduction, in this case, is zero.
The solution is to establish an S corporation for the eyeglass business alone. Then, you can claim a $40,000 QBI deduction.
4. Harvest capital losses
Say you are married filing jointly, and you earn a 2020 1099 income of $450,000 as a physician, as with our first example. Assume your taxable income is $500,000, with $100,000 as a capital gain income. You would not get any QBI deduction.
However, if you have unrealized capital losses of $100,000, and you sell your investments before December 31 and recognize the capital loss, your QBI would be $15,960. Note that you can buy back those investments after 30 days and still recognize the capital loss.
5. Claim Section 179 or bonus depreciation on new business assets
Using the example that you are making $450,000 with $400,000 in taxable income, say you purchase a new car for $50,000, and it weighs more than 6,000 lbs. You use this car 100% for your business. On top of a Section 179—a bonus depreciation deduction of $50,000—you can also claim a QBI deduction of $47,165. That’s over $97,000 in deductions.
6. Fund your retirement plan
With the same income and tax situation, let’s look at a retirement plan strategy. Say you open a solo 401(k) plan with $57,000. On top of your retirement plan contribution deduction of $57,000, you will also get a QBI deduction of $54,933. In this way, the tax savings almost pay for the retirement plan contribution.
7. Make charitable contributions
If you make an extra $25,000 in charitable contributions throughout the year, you’ll be able to claim a QBI deduction of $23,963 on top of the deduction of the full $25,000.
8. Review self-rental agreements
Let’s assume you’re self-employed as a physician through an S corporation, and you own your office building (in an LLC). Your monthly payment for the rental is equal to the mortgage payment.
If you increase your rent payment by $2,500 to reflect the fair rental value, your QBI deduction will increase by $6,000. This will also work the same way for any equipment in your medical practice or a vehicle. If you put that equipment into another entity and lease it out at fair rental value, that rental income will qualify for the 20% QBI deduction.
9. Review partnership agreements
If you are married filing jointly and are in a partnership that is a multi-physician practice, consider a situation where you receive a guaranteed payment of $350,000 with $300,000 of that being taxable. The QBI deduction would be zero. But, if you amend the partnership agreement and replace the guaranteed payments with a special allocation formula, the QBI deduction will be $60,000 (20% of the $300,000 in taxable income).
10. Maximize your business deductions
If you can claim additional business deductions, you can also boost your QBI deduction. Let’s use our initial example of the $450,000 in income. Business deductions could be for a home office, a 14-day rental of your home, employing your children, paying a management fee to a C corporation, and others. Let’s say you can claim $75,000 extra in these deductions during the year. In addition to that deduction, you will be able to claim a QBI deduction of $65,000.
Working with a tax professional
As you begin tax planning this year, keep these 10 strategies in mind to maximize the QBI deduction. If you’re unsure how to start, get in touch with the tax professionals at Physicians Tax Solutions. Our experts will look at your situation and help you pay the least amount of tax legally possible.
Physician Tax Solutions supports busy medical practitioners with proactive strategies and full-service tax preparation services that dramatically reduce tax bills. Contact us online or by calling 1-855-693-7829 to start saving today.