Maximizing QBI Deduction

By Terry Westlund, Co-Founder

Note: This post was updated to reflect 2019 numbers.

Remember the big hub-bub about tax reform at the end of 2017? The new rules included a significant change that benefited many independent contractor physicians (those with 1099 income). If you are a 1099 provider, the Qualified Business Income (QBI) deduction – also known as the “20% pass-through deduction”, gives you the potential to save quite a bit in taxes. Before the new tax rules were finalized, there was question around whether medical professionals would be able to take advantage of this new rule. Just to be clear, this 20% pass-through DOES apply to 1099 physicians… if you qualify….

So how do I qualify?

Before I answer that question, it’s important to be clear on how to calculate TAXABLE INCOME. Taxable income is simply your income minus any deductions or exemptions allowed in the tax year.

For married individuals, the goal is to reduce your taxable income to $321,400 to get the full benefit of this new tax rule. At this point you can apply a 20% deduction… $321,400 x 20% = $64,280. At a 24% tax rate, that saves $15,427 in taxes! Not too shabby. Does $321,400 seem like an impossible number to achieve? Ask your financial adviser about Defined Benefit Plans or hiring a spouse. If implemented appropriately, these kinds of plans can allow you to save upwards of $100,000 for retirement and therefore further reduce your taxable income.

If your taxable income is between $321,400 and $421,400 (for married filing jointly), you can still save on taxes through the phase-out portion of the new pass-through rule (“dollar for dollar”). For single taxpayers, the taxable income limits phase out from $160,700 to $210,700.

Don’t forget as an independent contractor, you have many ways to lower your taxable income including deducting health insurance premiums, HSA contributions, 50% of social security & Medicare tax, retirement contributions (up to $56,000 in 2019 or $62,000 for individuals age 50+… more with a DBP as described above) and deductible business expenses. Historically retirement contributions were typically one of the largest deductions you can make. Now the QBI deduction has the potential to be an even greater deduction.

20% Pass-Through Deduction Example

Sometimes it is easier to explain tax rules with an example. John Doe, MD, an emergency physician, is married and has $440,000 of I.C. income. Here is how he will utilize this deduction:

Business Income $440,000
Deductible Business Expenses ($15,000)
50% of S.S. & Medicare Tax ($13,500)
Health Insurance ($10,500)
Individual 401(k) Contribution ($56,000)
Net Business Income $345,000
HSA Contribution ($7,000)
Standard Deduction ($24,400)
Taxable Income $313,600
QBI Deduction ($62,720)
Net Taxable Income $250,880

At a 24% tax rate, Dr. Doe will be saving approximately $15,000 in taxes by utilizing the new QBI deduction. Now that’s worth paying attention to!

What if I generate W-2 and 1099 income?

Technically the deduction is calculated from whichever is lower… your “Net Business Income” or your “Taxable Income”. If you only have 1099 income, your “Taxable Income” is usually the lower amount. If you have W-2 income to also account for, you may find yourself taking 20% of your “Net Business Income” as it may be the lower of the two. Here is an example: Emily has $325,000 of independent contractor income and $100,000 in W-2 wages:

Business Income $325,000
Deductible Business Expenses ($15,000)
50% of S.S. & Medicare Tax ($6,000)
Health Insurance ($8,000)
Individual 401(k) Contribution ($56,000)
Net Business Income $240,000
HSA Contribution ($7,000)
Standard Deduction ($24,400)
W-2 Income $100,000
Taxable Income $308,600
QBI Deduction ($48,000)
Net Taxable Income $260,600

The 20% pass-through deduction is calculated from the “Net Business Income” as it is lower than the “Taxable Income”, resulting in a deduction of $48,000 ($240,000*20%). This is still about a $11,500 savings in tax at a 24% tax rate!

Any other considerations I should be aware of?

Historically we recommended medical professionals making over $330,000 should consider forming an S-Corp to save more in taxes. With the new 20% pass-through deduction, work with your CPA to determine if the way your S-Corp is set-up truly maximizes your tax savings. You may need to make an adjustment to your flow-through income or consider dissolving the S-Corp to take full advantage of the 20% pass-through deduction. For more information on entity formation, see one of our blog entries here.

For more details on how this deduction might work within your tax strategy, contact your tax professional or our experienced team. You can reach us at 888-898-3627 or make an appointment here: https://www.appointmentcore.com/app/freeslots/KpvdtvV

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