It's important to do year-end tax planning for your possible 20 percent Qualified Business Income (QBI) Section 199A tax deduction, courtesy of the Tax Cuts and Jobs Act (TCJA). If your taxable income is above $160,700 (or $321,400 on a joint return), this article is a must-read. If you ignore Qualified Business Income (QBI) Section 199A planning, you will be penalizing yourself by losing out on a potential 20 percent deduction.
If your taxable income is above $163,300 (or $326,600 on a joint return), then consider using one or more of the strategies described below to increase your QBI Section 199A deduction.
Strategy 1: Harvest Capital Losses
Capital gains add to your taxable income, which is the income that:
- Determines your eligibility for the QBI (Section 199A tax deduction)
- Sets the upper limit (ceiling) on the amount of your Section 199A tax deduction
- Establishes when you need wages and/ or property to obtain your maximum deductions
If the capital gains are hurting your Section 199A deduction, you have time before the end of the year to harvest capital losses to offset those harmful gains.
Strategy 2: Charitable Contributions
Since the Section 199A deduction uses taxable income for its thresholds, you can use itemized deductions to reduce and/or eliminate threshold problems and increase your Section 199A deduction. Also, the CARES Act allows a 100 percent deduction for cash contributions.
Charitable contribution deductions are the easiest way to increase your itemized deductions before the end of the year. Consider doing one or both of the following:
- Donate appreciated stock
- Prepay (before Dec. 31) your planned 2020 charitable contributions so you can claim them as deductions this year
Strategy 3: Buy Business Assets
I don't consider creating an expense (asset purchase) an ideal tax planning strategy unless you need the asset. However, thanks to a 100 percent bonus depreciation and Section 179 expensing, you can write off the entire cost of most assets you buy and place in service before Dec. 31, 2020. This can help your QBI Section 199A deduction in two ways:
- The big asset purchase and write-off can reduce your taxable income and increase your Section 199A deduction when it can get your taxable income under the threshold.
- The big asset purchase and write-off can contribute to an increased Section 199A deduction, which in turn increases the deduction you already depend on.
An Example to Consider
Dr. Jim, who is single, runs his chiropractic practice as an S corporation. He has taxable income of $211,000, and the S corporation has a K-1 QBI of $120,000 and wages of $120,000.
If Jim takes no action, his Section 199A deduction is $0, because his taxable income is over the upper threshold of $210,700 and his chiropractic practice is an out-of-favor specified service business.
But let's say that before Dec. 31, 2020, Jim buys and places in service a $30,000 cold laser he had planned to buy over the next one to two years. Assuming Jim can fully expense it, he saves $18,123 in federal income taxes:
- $9,807 from the equipment write-off (35 percent of $6,900 plus 32 percent of $23,100).
- $8,316 from the Section 199A deduction (Note: After expensing the $30,000, Jim has $181,000 in taxable income, which is above the $163,300 threshold, meaning that he is in the phaseout range.)
With the expensing, Jim reduced his taxable income to $181,000 ($211,000 minus $30,000). He also reduced his QBI to $90,000 ($120,000 minus $30,000).
Takeaways
If your taxable income is over $163,300 (or $326,600 on a joint return), you could face a reduced or eliminated Section 199A deduction. In such cases, consider using one or more of the three strategies described in this article to reduce your taxable income and increase your Section 199A deduction. The combination gives you a double hit, reducing your taxes.
- Harvest capital losses if you have capital gain income that's causing the trouble.
- Make charitable contributions to increase your itemized deductions and reduce your taxable income; and consider donating appreciated long-term-gain stock to come out even better.
- Buy and place in service before midnight on Dec. 31, 2020, business assets that you can expense 100 percent to lower your taxable income.
Final Point
Author's Note: This can get confusing. Be sure to have a conversation with your CPA or contact us at www.chirotaxpro.com for a QBI review.
Don Rasmussen is a certified tax coach and seasoned tax reduction strategist with nearly three decades of experience working with individuals, businesses and charities. He is also a sought-after speaker on tax and financial issues, and a featured contributor to Fox Business and The Slott Report.