For financial advisors, the new Qualified Business Income (QBI) deduction (also known as the IRC Section 199A deduction, or the pass-through deduction) presents not just many tax planning opportunities for small business owner clients, but also tax planning opportunities for financial advisors themselves. The reason being that financial advisors are classified as Specified Service Business owners, and, as a result, any “high income” advisors (defined as those whose taxable income exceeds $315,000 when filing a joint return, or $207,500 when filing otherwise), are subject to a phaseout of their potential full QBI deduction of up to 20% of certain business income.
In this guest post, Jeffrey Levine of BluePrint Wealth Alliance, and our Director of Advisor Education for Kitces.com, examines how high-income financial advisors (and other Specified Service Businesses) can utilize strategies to get the most benefit from their QBI deduction, including spinning off and renting back depreciable property, creating a PEO and leasing back employees, condensing lifetime giving via the use of a donor-advised fund, and other strategies!
While high-income advisors need to consider the impact of the QBI phaseout on their income going forward, notably, the concern does not apply to all advisors. In particular, advisors with income less than the QBI phaseout levels will still receive a full QBI deduction. But for high-income advisors, the QBI phaseout will apply. As a result, advisors may particularly want to look for strategies to convert an advisor’s specified service business income into income derived from a non-specified trade or service business. Advisors have many options for implementing such strategies. For instance, some may want to spin off any firm owned real estate into a separate entity and lease back the property at fair market value. By doing so, an advisor can reduce the amount of specified service business QBI generated from their practice (as rent is a deductible business expense), while simultaneously increasing the amount of QBI generated from the separate “rental real estate business”, which is not a specified service business. The end result of the strategy is that the rent the advisor pays on the building would be eligible for the 20% QBI deduction (albeit with a cap of up to 2.5% of the unadjusted basis of the office space).
Similarly, other QBI strategies look for ways to reduce QBI generated from an advisor practice while also increasing QBI generated by a non-specified service business. For instance, advisors may want to “spin-off” non-advisory employees and lease them back through a professional employer organization (PEO) (as a PEO would be eligible for a QBI deduction, so long as it is not deemed an advisory business), license intellectual property to an advisory firm through a different entity (as the intellectual property income may be eligible for a QBI deduction), or even cut back their workload or increase their investment in their firm through deductible expenses, given the marginal tax rates that can reach as high as 64% within the QBI phaseout zone!
Ultimately, the key point is to acknowledge that high-income financial advisors (and other specified service business owners) have considerable opportunity to plan around the new QBI phaseout zone… even if their total income is well beyond the QBI phaseout zone! While the new rules can be a bit tricky (and strategies could shift as the IRS provides more guidance going forward), it appears that QBI strategies will be a key focus going forward, and present a considerable planning opportunity for advisors (and their clients!) to reduce their overall tax burden!
source https://www.kitces.com/blog/high-income-threshold-qbi-deduction-strategies-financial-advisor-specified-service-business/
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