The clock is ticking on Section 199A of the 2017 Tax Cuts and Jobs Act (TCJA)—the Qualified Business Income Deduction. Since its inception, this provision has significantly impacted small business owners and entrepreneurs.
With the deduction set to expire at the end of 2025, understanding its implications and planning for the future is crucial. This guide will equip you with all the insights and strategies you need to prepare for this significant change.
What is the Qualified Business Income Deduction?
Understanding the QBI Deduction
Introduced as part of the TCJA, the Qualified Business Income (QBI) Deduction allows eligible business owners to deduct up to 20% of their qualified business income from their taxable income. This deduction aims to provide a tax break to pass-through entities, ensuring that small and medium-sized businesses receive tax benefits similar to those major corporations enjoy.
How the Deduction Works
Calculating the QBI deduction can be complex. Generally, it allows for a 20% deduction on qualified business income.
However, several factors influence the exact amount, including the business owner’s taxable income and the type of business. The deduction is also subject to limitations based on income levels and business sector, making it essential to understand the nuances to maximize benefits.
Who Qualifies for the Deduction?
The QBI Deduction is available to various business entities, including sole proprietorships, partnerships, S corporations, and certain trusts and estates. You may be eligible for this deduction if your business is a pass-through entity. However, there are further specific requirements and limitations to consider.
Income Thresholds and Phase-Outs
The QBI Deduction is also subject to income thresholds and phase-outs. For example, in 2024, the deduction starts to phase out for single filers with taxable income above $191,950 and joint filers above $383,900. Understanding these thresholds helps you plan your finances and optimize your tax liabilities.
Specified Service Trades or Businesses (SSTBs)
Certain businesses, known as Specified Service Trades or Businesses (SSTBs), face additional restrictions when claiming the QBI Deduction.
These include professions in health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.
These businesses aren’t qualified for the deduction at income levels above the threshold and phased-in range, making it more challenging to benefit from the provision.
W-2 Wage and Capital Limitations
Another critical aspect of the QBI Deduction involves W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property.
For businesses above the income threshold, the deduction is limited to the lesser of 20% of QBI or the greater of 50% of W-2 wages paid by the business or 25% of W-2 wages plus 2.5% of the UBIA of qualified property. These specificities add another layer of complexity to the calculation process.
The Impending Expiration of the TCJA
Sunset Provision
The TCJA, including the QBI Deduction, will expire at the end of 2025 unless Congress takes action to extend or modify it. This sunset provision means that the tax benefits many business owners have enjoyed over the past few years may no longer be available, leading to higher taxable incomes and increased tax liabilities.
Legislative Context
The legislative landscape surrounding tax provisions is constantly evolving. While Congress could extend or modify the QBI Deduction, relying on legislative actions is risky. A better option is to prepare for the worst-case scenario while remaining hopeful for its extension.
Impact of the Expiration on Business Owners
Increased Taxable Income
When the QBI Deduction expires, many business owners will face higher taxable incomes. This increase could be significant, especially for those who have significantly benefited from the 20% deduction.
Higher Tax Liabilities
Higher taxable incomes naturally lead to higher tax liabilities. Business owners who have come to rely on the savings provided by the QBI Deduction need to prepare for this shift. Understanding and planning for how much more you might owe is essential.
Example Scenario
Consider a small business owner who benefits from a $50,000 QBI Deduction annually. If the deduction expires, this business owner’s taxable income could increase by $50,000, leading to a substantial rise in their tax bill.
Planning can help mitigate the financial impact.
Planning for the Expiration
Tax Planning Strategies
To prepare for the expiration of the QBI Deduction, business owners should consider various tax planning strategies:
- Income Management: Consider deferring income or accelerating deductions to optimize your taxable income.
- Maximize Retirement Contributions to retirement plans like 401(k)s or IRAs. These contributions can reduce your taxable income and provide long-term financial benefits.
- Entity Restructuring: Review your current business structure with your accountant. Restructuring your business can sometimes provide tax benefits after the QBI Deduction expires.
Consulting with Tax Professionals
Given the complexities involved, consulting with tax professionals is highly recommended. A tax advisor, like the team at Pasquesi Partners, can help you develop a personalized strategy that considers your unique circumstances and the impending changes in tax law.
Consult with a Tax Planning Expert to Start Preparing Now
The expiration of Section 199A of the TCJA is a significant event that will impact many small business owners and entrepreneurs. Understanding the QBI Deduction, its implications, and planning for its expiration can help you mitigate the potential financial impact and ensure your business remains resilient.
Take proactive steps now to prepare for the upcoming changes. The team at Pasquesi Partners can help you develop a comprehensive strategy for navigating the expiration of the QBI deduction and optimizing your tax burden. Contact us today to position your business for continued success post-TCJA.