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Tax Reform Bill - Qualified Business Income Deduction

The GOP tax reform bill is expected to be signed into law by the end of this week, Dec. 22nd. The Qualified Business Income Deduction (QBID), part of this legislation effective for the 2018 tax year, allows qualifying pass-through entities to reduce their business income by up to 20%. QBID will be the focus of the post as it is of interest to dentists. For good summary of the tax reform bill, please read the following Business Insider article:

This discussion will be from the prospective of a dentist, either paid as a 1099 independent contractor or practice owner, who's formed a pass-through entity (i.e., S Corp, LLC, sole proprietor).

QBID General Overview

QBID allows qualifying pass-through entities to reduce their business income by up to 20%. Qualifying for QBID is based on the individual's taxable income:

  • For married couples – taxable income cannot exceed $315,000. QBID is phased out from $315,000 to $415,000. If your taxable income exceeds $415,000, you will not qualify of any QBID.

  • For single individuals – taxable income cannot exceed $157,500. QBID is phased out from $157,500 to $207,500. If your taxable income exceeds $207,500, you will not qualify for any QBID.

Critical to this deduction is taxable income (TI). TI is specific value found on your personal income tax return (line #43). TI is determined after a series of calculations. Being familiar with this calculation will better position you to benefit from the Qualified Business Income Deduction. Here's a somewhat simplified formula to determine taxable income as a practice owner:

Collections

less: Practice expenses

less: Retirement contributions

less: HSA contributions

less: Standard or Itemized Deductions (the greater of)

equals: Taxable Income

As it may now be more evident, managing your taxable income is critical. Maximizing your allowable deductions to minimize your taxable income may determine whether you qualify for the QBID.

How to Calculate the QBID?

Let’s assume that your table income falls within the thresholds. Further assume that your practice ordinary business income (line item #21 of the 1120S or line item #1 of the K1) is $185,000 and taxable income is $295,000 (line #43 on your personal income tax returns). QBID is the lesser of;

  • 20% of the ordinary business income = $37,000 (20% of $185,000),or

  • 20% of taxable income = $59,000 (20% of $295,000)

Again, the QBID calculation is pretty straight forward: $185,000 x 20% = $37,000 Qualified Business Income Deduction.

Now what? Well, for the 1st time, you can reduce your ordinary business income by $37,000 in this example. Given the new marginal tax brackets for married filing jointly, the estimated tax saving at the 24% marginal tax rate is $8,880 ($37,000 x 24%). This because of the new tax treatment for pass-through tax entities.

Thoughts/questions – let me know.

Revised as of 12/22/17 to excluded lesser of calculation. Sergio

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