Author: Jonathan Frost
If you’ve been following the news out of Washington this year (let’s be real, who hasn’t?), you may have heard about changes being made to the tax code. One of the changes made by the Treasury Department, the Qualified Business Income deduction, will specifically affect small business owners – but what do those changes mean and how will it affect your business?
Money & Mimosas reached out to Jonathan Frost, CPA and CEO of J.D. Frost & Company to get some more insight.
What is the Qualified Business Income deduction?
Qualified Business Income (QBI) is income or loss from any qualified trade or business during the tax year. This is income or loss is strictly related to normal business activity and not things like capital gains or losses, interest, dividends, or even compensation that has been paid to the taxpayer from the business through wages or guaranteed payments.
There are new regulations regarding QBI that could mean a significant opportunity for business owners. Taxpayers filing in 2019 may be eligible for a 20 percent deduction on their QBI from partnerships, trusts and estates, S corporations, or sole proprietorships from business conducted; however, the deductions are subject to limitations based on wages paid by the business that created the QBI.
This deduction is phased out at the threshold of $157,500 for specified service trades or businesses. After this level of income, the deduction is phased out in increments until the taxable income exceeds $207,500 or $415,000 for joint filers.
Below is an example of how QBI would impact a freelancer that earned $175,000 in 2018:
You are a consultant (one of the service provider categories subject to the phase out
limits) and a single taxpayer with adjusted gross income of $175,000
After the standard deduction for a single filer of $12,000, your taxable income is
You paid your employees $50,000 in wages
In this case, to calculate, first determine the phase-out limit, which is 50 percent of the W‐2
wages you paid since there is no qualified property. This is equal to $25,000 (50% x $50,000
W‐2 wages = $25,000). Next, determine what would be 20% of your adjusted gross income.
This would be $35,000 (20% x $175,000 AGI = $35,000). The lower number is $25,000, so this
would be your deduction. So, taxable income would change from $163,000 to $138,000. How does this deduction change your tax situation from previous years? The answer, as you
might expect, is somewhat complicated because each situation is unique. (Yes, this is why tax planners continue to have a job.)
This new deduction may offer very significant savings to your freelance consulting business, but it all depends on how the rules apply to your specific career and income.
Do you qualify for the QBI deduction?
At this point, you’re probably wondering if you qualify for this deduction. The first step is to find out if your profession is included in the “specified service trade or business” category.
This includes any trade or business that involves services performed in the following fields:
Trades or businesses involving investing and investment management
Any trade or business “where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.” This may include consultants like personal trainers, life coaches, and other "cult of personality" businesses.
When in doubt, ask a tax advisor
While many of the provisions in the tax reform bill are relatively straightforward, this deduction can get a bit complicated for many professions. For example, qualifying could mean restructuring your compensation (like a cash-based retirement plan) or making a higher investment in business capital to limit your taxable income.
Keep in mind that this deduction is currently only in place until 2025. For some of you, these provisions won’t necessarily simplify your tax reporting, but it’s worth exploring to see if you are eligible to take this deduction.
Jonathan Frost is an innovator in the accounting and business industries who successfully owns and manages a variety of businesses. Currently he is the CEO/CMO of his own accounting firm J.D. Frost & Company, PLLC in Chattanooga, TN as well as the host of the podcast series "The Stage 2 Show: How to Grow from Operator to Rainmaker." Driven by the desire to continuously grow, he uses his experiences in accounting and business to not only grow and improve his businesses, but those around him. Jonathan has become a trusted advisor to many entrepreneurs as well as established business owners. He has helped them cultivate their business, establish systems, and take their business to the next level.
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