Close Close
Sign In
Newsletters
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Podcast Center Video Center Webcasts Resource Center Events
About ThinkAdvisor Contact Us Advertise With Us Asset & Logo Licensing Sitemap Terms of Service Privacy Policy Copyright © 2024 ALM Global, LLC. All Rights Reserved.
ThinkAdvisor
Robert Bloink and William H. Byrnes

Financial Planning > Tax Planning

How High Earners Can Maximize This Business Tax Deduction Before It Disappears

By Robert Bloink By William H. Byrnes

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • The 20% deduction for qualified business income can greatly reduce tax liability for partnerships, S corps and other pass-through entities.
  • Income restrictions limit the availability of the deduction for higher-earning service businesses.
  • The tax treatment is set to expire entirely after 2025 if Congress does not legislate an extension.

The 2017 tax overhaul fundamentally changed the tax treatment of pass-through business entities through the enactment of Section 199A.

The 20% deduction for qualified business income can greatly reduce tax liability for the owners of partnerships, S corps and other pass-through entities. That said, the deduction isn’t available to all businesses. Income restrictions serve to limit the availability for higher-earning pass-throughs who are classified as service businesses. 

There are steps that taxpayers can take to maximize the value of the deduction — and many taxpayers may be forgetting that Section 199A is scheduled to expire entirely after 2025 if Congress does not legislate an extension.

Taxpayers interested in maximizing the tax treatment of qualified business income while simultaneously funding their retirements should act quickly to take advantage of this potentially limited deduction.

Business clients may be overlooking valuable tax savings if their circumstances have changed since Section 199A became law. Those clients who can reduce their taxable income to below the threshold levels may wish to act before the deduction goes away.

Limitations on the Deduction

The 2017 tax reform legislation allows pass-through entities to deduct 20% of “qualified business income” through 2025. Yet entities that are classified as “service businesses” (including attorneys, accountants, doctors, financial advisors and certain other professionals) are not entitled to the full benefit of the deduction if the business owner’s taxable income exceeds certain threshold amounts. 

The applicable threshold levels for 2024 are $383,900 (married filing jointly) or $191,950 (single filers), and the deduction is phased out for service business owners with income between the threshold levels plus $50,000 for individual filers or $100,000 for joint filers. This means that clients who own service businesses and have taxable income that exceeds $483,900 (married filing jointly) or $241,950 (single filers) will not benefit from the deduction.

Because the deduction is so valuable, entities that are classified as service businesses should aim to reduce taxable income to below the applicable thresholds if possible. Of course, for many taxpayers, that can be a challenge. Retirement plans can play a significant role in allowing business owners to maximize the value of the deduction.

Options for Reducing Taxable Income

Many business owners already have a 401(k) plan or SEP-IRA program in place. Those clients should be reminded to take advantage of expanded contribution limits for employers. 

For 2024, employers can contribute up to $69,000 to their own retirement plan, assuming they have the income to support the contribution. Taxpayers who are at least 50 years old should also take advantage of their catch-up contribution to 401(k) plans to increase their contribution to $76,500 in 2024.

For clients who have not established a retirement plan, the SEP-IRA option may be most appealing if the business has few or no employees. If employers contribute any amount for any given year, they must make uniform contributions to the accounts of all employees for that year.

Because contributions are not required to be made to a SEP every year, a small-business client could establish the plan primarily to take advantage of the qualified business income deduction. If the deduction is allowed to expire, the employer could reevaluate its SEP contributions.

However, clients with more employees may be more attracted to a traditional 401(k) plan, where employer contributions are not mandatory.

For business owners with higher income levels, SEP-IRAs and 401(k)s may prove insufficient to reduce their taxable income to take advantage of the deduction. These clients may wish to establish a defined benefit plan or cash balance plan, which can allow for much larger contributions to reduce higher income levels to below the applicable thresholds.

Cash balance plans are more complicated to administer but do generate large deductions from taxable income. The employer will need an actuary to compute the level of contributions that may be made.

Cash balance plans provide for a guaranteed benefit level at retirement. Like defined contribution plans, the cash balance plan is funded annually by fixed contributions. The plan sponsor does bear the risk and responsibility for funding the plan. However, the benefits can be significant, especially for businesses with few employees. 

Contribution levels are based on age. For 2024, the maximum contribution for a 60-year old is $318,000. A 70-year old can contribute as much as $409,000.

  • Learn more with Tax Facts, the go-to resource that answers critical tax questions with the latest tax developments. Online subscribers get access to exclusive e-newsletters.
  • Discover more resources on finance and taxes on the NU Resource Center.
  • Follow Tax Facts on LinkedIn and join the conversation on financial planning and targeted tax topics.
  • Get 10% off any Tax Facts product just for being a ThinkAdvisor reader! Complete the free trial form or call 859-692-2205 to learn more or get started today.

Robert Bloink

William H. Byrnes

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.