QBI Deduction for Business Owners: Strategies, Risks, and the Future
The Qualified Business Income (QBI) deduction, introduced by the Tax Cuts and Jobs Act (TCJA) of 2017, provides significant tax savings for many business owners. If you operate a pass-through entity like a sole proprietorship, partnership, or S corporation, you may qualify to deduct up to 20% of your qualified business income. With the deduction set to expire at the end of 2025, understanding how it works and preparing for potential changes is essential to minimizing your lifetime taxes as a business owner.
Quick Background: What Is the QBI Deduction?
The QBI deduction lets eligible taxpayers reduce their taxable income by up to 20% of their qualified business income. Unlike other deductions, it directly reduces taxable income, which can significantly lower your tax bill. However, this deduction has a sunset provision and will expire on December 31, 2025, with the Tax Cuts and Jobs Act unless the bill is extended.
Who Qualifies for the QBI Deduction?
Eligibility is based on:
Income thresholds: For 2024, single filers with taxable income up to $191,950 and married filers up to $383,900 can claim the full deduction. Above these limits, restrictions apply.
Specified Service Trades or Businesses (SSTBs): Professions like healthcare, law, and consulting face stricter rules if income exceeds the thresholds.
Entity type: Pass-through entities such as sole proprietorships, partnerships, S corporations, and certain trusts are eligible.
Strategies to Maximize the QBI Deduction
To get the most from the QBI deduction, consider these strategies:
1.Manage Your Taxable Income: The QBI deduction is only fully available if your taxable income falls below certain thresholds—$191,950 for single filers and $383,900 for joint filers in 2024. Once you exceed these thresholds, limitations apply, especially for Specified Service Trades or Businesses (SSTBs).
Actionable Tips:
Accelerate deductible expenses: Move expenses like equipment purchases, marketing, or charitable contributions into the current year to reduce taxable income.
Defer income: Postpone receiving income until the next tax year, especially bonuses or client payments.
Use retirement contributions: Contributing to accounts like 401(k)s, SEP IRAs, or defined benefit plans reduces taxable income while funding your retirement.
Example: A sole proprietor nearing the income threshold could fund a SEP IRA with up to $66,000 (for 2023 limits) to lower taxable income and potentially qualify for the QBI deduction.
2. Pay W-2 Wages: For businesses earning above the income threshold, the deduction is limited to the lesser of:
20% of QBI, or
50% of W-2 wages paid by the business.
If your business doesn’t pay W-2 wages, or pays too little, you may lose part or all of the deduction.
Actionable Tips:
Hire employees: If you’re a sole proprietor or single-member LLC, consider hiring employees and paying W-2 wages instead of relying solely on contractors.
Adjust owner compensation: In S corporations, ensure your W-2 wages as an owner are reasonable but high enough to maximize the QBI deduction.
Example: A consultant earning $400,000 structured as an LLC may not qualify for the deduction if no wages are paid. By hiring a part-time employee at $60,000, the consultant could reclaim part of the QBI deduction.
3. Restructure Your Business: Your business structure plays a significant role in QBI eligibility. Pass-through entities, like S corporations, partnerships, and sole proprietorships, qualify. However, the way you allocate income and expenses can influence the deduction.
Actionable Tips:
Convert to an S corporation: If you’re a sole proprietor or LLC, consider converting to an S corporation. This allows you to pay yourself W-2 wages, which may help you meet QBI wage limitations.
Reallocate income streams: If your business generates multiple income streams, separate them to identify qualified business income and optimize deductions.
Work with a tax professional: A tax advisor can help you evaluate if restructuring your business would provide long-term benefits.
Example: An LLC owner making $500,000 could convert to an S corporation, paying $150,000 in wages. This satisfies wage-related limitations and preserves some of the QBI deduction.
4. Maximize Retirement Contributions: Contributing to retirement accounts is a twofold benefit: it reduces taxable income and boosts long-term financial security. Lowering your taxable income can help you qualify for or increase the QBI deduction.
Actionable Tips:
Use 401(k)s and defined benefit plans: High-income earners can contribute significant amounts to these plans, reducing taxable income by tens of thousands of dollars.
Establish a SEP IRA or SIMPLE IRA: These plans are ideal for smaller businesses looking for flexible contribution options.
Leverage cash balance plans: For business owners with high income, combining a cash balance plan with a 401(k) can create even greater tax savings.
Example: A married business owner with $400,000 in taxable income contributes $75,000 to a defined benefit plan. This reduces taxable income to $325,000, qualifying the owner for the QBI deduction and saving an additional $10,000 in taxes.
Case Study: Sarah’s Marketing Agency
Sarah owns a successful marketing agency structured as an LLC. In 2024, her taxable income is projected at $420,000, above the QBI deduction threshold for joint filers. To maximize her tax benefits, Sarah works with her financial advisor and implements these strategies:
Increases W-2 wages: Sarah increases her wages to $150,000 to meet the wage-based calculation for the deduction.
Contributes to retirement accounts: She contributes $50,000 to her company-sponsored retirement plan, reducing her taxable income.
Defers income: Sarah postpones an additional $20,000 in bonuses until 2025.
By using these strategies, Sarah lowers her taxable income to $350,000 and secures a QBI deduction of $50,000, saving an estimated $10,000 in federal taxes.
The Risk of Losing the QBI Deduction
The QBI deduction is set to expire in 2025. Without legislative action, business owners will lose access to this valuable tax-saving tool. Potential scenarios include:
An extension of the QBI deduction.
Changes to income thresholds or eligibility rules.
Allowing the deduction to lapse entirely.
Proactive tax planning is critical to mitigate the impact of losing the deduction.
What a Trump Presidency Could Mean for the QBI Deduction
As the original architect of the TCJA, Donald Trump’s return to the presidency could influence the QBI deduction’s future. While Trump may support extending the deduction, broader tax reform priorities and political negotiations could alter its provisions. Business owners should prepare for all possibilities. As we say, "Hope for the best, but plan for the worst."
The QBI deduction offers substantial savings for eligible business owners, but its complexity and uncertain future demand attention. By planning now, you can maximize its impact and stay ahead of potential changes, ensuring you keep more of your hard-earned income.
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Securities and advisory services offered through LPL Financial, a registered investment Advisor, Member FINRA/SIPC. This does not represent tax or legal advise, please consult your tax or legal professional.
