The Tax Cuts and Jobs Act (TCJA) included the most substantial changes to the tax code that we have seen in over 30 years. Perhaps the change which has garnered the most attention amongst financial advisors appears to be the new 20% deduction for qualified business income (QBI). What’s unique about the QBI deduction (also known as the IRC Section 199A deduction, or the pass-through deduction) is not just the size of the deduction (as a deduction of up to 20% of certain business income is likely to generate interest) but the fact that many financial advisors themselves will be eligible for a QBI deduction, albeit subject to some “high-income” limitations that many financial advisors will need to plan for in order to avoid having their QBI deduction phased-out entirely.
In this guest post, Jeffrey Levine of BluePrint Wealth Alliance examines how financial advisors (and other Specified Service Businesses) can maximize their QBI deduction through business entity selection, including why employee advisors may want to convert to being independent contractors; why S corps may want to convert to partnerships, LLCs, or a C corp (or not!); and why sole proprietors may not need to make any changes.
A key to understanding the new QBI deduction is how the “high-income” phaseout works. For QBI purposes, any specified service business owner who files a joint tax return with more than $315,000 of taxable income, or an advisor who files under any other status with taxable income of more than $157,500, will be considered “high-income”. As a result, high-income advisors will be subject to a phaseout of their QBI deduction, with the deduction being completely phased out when taxable income reaches $415,000 (joint) or $207,500 (other). Notably, since these thresholds are based on taxable income, this would include income from any sources (investment, spouse, etc.), even though the QBI deduction itself is calculated based on the business’ income.
The reason business entity selection influences an advisor’s QBI deduction is that not all compensation to an advisor is considered qualified business income. For instance, financial advisors who receive W-2 wages are not eligible for a QBI deduction at all, which is why employee advisors may want to consider converting to become independent contractors (if their employer will allow it), as their sole proprietor income would be considered QBI. Income from partnerships or LLCs taxed as partnerships will generally be considered QBI, with the exception of guaranteed payments made to partners (which may mean advisors utilizing operating agreements with substantial guaranteed payments may want to reconsider this structure in light of QBI considerations). The good news for S corps is that so long as advisors can reasonably claim a lower salary, profit distributions (but not wages) will avoid self-employment taxes and be considered QBI (although this extra incentive to push the boundary of what may be considered reasonable salary will also likely mean extra IRS scrutiny of S corp income). For C corp owners, wages again are not considered QBI, although such owners may still benefit from the reduced corporate tax rate of only 21%.
Ultimately, the key point is to acknowledge that business entity selection plays a key role in maximizing a QBI deduction as a specified service business owner. Although many financial advisors (and other specified service business owners) may be subject to a QBI phaseout due to their high income, choosing the right business entity structure can help advisors preserve as much QBI deduction as possible!Read More…
source https://www.kitces.com/blog/section-199a-business-entity-choices-qualified-business-income-qbi-deduction-strategies-financial-advisor-specified-service-business-phaseout/
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