Underappreciated Tax Reduction Strategies for Business Owners
I think that we can all agree that 2020 has been a long, long year, but one thing that is finally over is 2020’s never-ending tax season! Entrepreneurs feel that they can now move on from that painful task and focus solely on running their businesses…ahhh, but should you? Not so fast!
As of writing this, even though 2020 already feels 18 months long, there are less than five months left in the year. Why does that matter? Because some of the very best tax reduction strategies require time to analyze and implement.
The more intricate the tax strategy, the more analysis, planning and implementation time will be required. Truth be told, some strategies require as much as two months to administratively and operationally complete. In addition, there are important deadlines for setting up these plans for 2020.
Here are a couple of underused strategies that you should talk with us and/or your CPA about sooner rather than later.
The Qualified Business Income Deduction
One of the most underutilized tax reduction strategies is the Qualified Business Income deduction or QBI. It was an important part of the Tax Cuts and Jobs Act tax bill passed in December of 2017, and it allows for the deduction of up to 20 percent of business income, plus qualified real estate investment trust dividends, and publicly traded partnership income.
Do I qualify?
To qualify you must be a sole proprietor, partnership, or S Corp. Additionally there are limitations on the type of trade or business, and the amount of W-2 wages paid. Importantly, income from capital gains, or dividends aren’t considered. As such, for the business owner who may receive both W-2 income and a dividend from the K-1 for their S Corp, strategic planning for wage versus dividends becomes critical.
Specifically, there income limits on who can take advantage of the deduction, after which phase out begins; $163,300 for single taxpayers and $326,600 for married couples. So long as the dividends paid to the owner from the business K-1 is deemed reasonable, and the household income is below the threshold, the more that is paid in dividends, the bigger will be the deduction from the QBI before the dividend is paid. Again, this requires some planning, so consult your CPA or tax professional early on any such strategies.
The 412(e)(3) Plan
Another important strategy that is little understood, even by many tax and financial professionals, is called a 412(e)(3) plan. It has very specific benefits for the right situation. It allows for the owners of a small business with fewer than five employees to contribute substantially more to their defined benefit plan than otherwise would be the case, allowing for a greater tax deduction for this and future years.
A 412(e)(3) plan also provides for secure guaranteed retirement income; it is most desirable for an older business owner with younger employees, especially highly profitable businesses that are likely to continue to be profitable for the foreseeable future. Also, this plan is generally exempt from lawsuits.
Top line…How does it work?
The guarantee comes in the form of a life insurance contract if health is not an issue, or an annuity if otherwise. The contributions can be made by the employer or a custodial trust. The payments are made in frequent level installments until the age of retirement.
Have either of these strategies caught your interest? There are many other considerations that will need to be examined, since these programs have many restrictions and requirements. But if you would like to learn more about them and see if one or both may apply to you, please reach out to the Modernize Wealth team at 480-346-1283, or email email@example.com.