Can increasing your retirement savings qualify your business for an additional deduction?

Many argue that the Tax Cuts and Jobs Act (TCJA) enacted in December 2017 did not accomplish the goal of simplifying the Tax Code, particularly as it relates to the newly created Internal Revenue Code Section 199A. Although it may be complex, this new Code section offers qualifying businesses potential tax savings.

Section 199A provides business owners and certain real estate investors using pass-through entities (e.g., partnerships, S Corporations and sole proprietorships) with up to a 20 percent deduction on “qualified business income” (QBI). Although the definition of QBI is beyond the scope of this article, it can be summarized as the total of the business’ taxable income, W-2 wages and unadjusted basis immediately after acquisition.

If the type of entity is a “specified service” business (defined in Code Section 1202(e)(3)(a)), the deduction begins to phase out for single filers with a taxable income of $157,500 and married individuals filing jointly with taxable incomes of $315,000; the deduction is completely eliminated for single filers with more than $207,500 of taxable income and married individuals filing jointly with more than $415,000 of taxable income.

Even if a specified service business exceeds the aforementioned income thresholds, the business may take advantage of the 20 percent deduction under 199A if it can reduce its business income below the income maximums. Two easy ways to accomplish such a reduction are to increase contributions to a current retirement plan(s) or to adopt a new retirement plan(s). Doing so not only reduces the business’ taxes by qualifying for the 199A 20 percent deduction, but it also enhances the retirement security of the owners and their employees.

A plethora of employer-sponsored retirement vehicles are available to small employers, including simplified employee pensions (SEPs), SIMPLE plans, profit sharing plans and 401(k) plans. The plan best suited for a particular employer depends upon each employer’s employee demographics and the dollar amount the employer wishes or needs to contribute to a plan in order to reduce its QBI to the qualified deduction level. While defined contribution plans such as profit sharing and 401(k) plans currently limit annual contributions to $56,000 per participant, defined benefit plans and cash balance plans may allow an employer to shelter $100,000 or more per participant.

If it is determined that a reduction in the QBI will qualify your business to take advantage of the 20 percent tax deduction under Code Section 199A, Chuhak & Tecson Tax & Employee Benefits attorneys have the knowledge and experience to advise and guide you and your business through the process of analyzing which retirement vehicle(s) would best serve your business needs.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Patricia Cadagin O'Brien, Principal

This alert originally appeared in the Spring 2019 Corporate Focus newsletter.