Hi, everyone.
This is the How to Lower Your Tax Bill podcast.
I'm your host, Terrence Hutchins.
I'm a financial and tax advisor in the Dallas forward area.
And the goal of this podcast is to help you listeners get educated with different tax
strategies that you can implement to improve your tax situation immediately.
In this episode, we'll break down useful tax tips you can use to save money no matter what
your personal or business income situation.
Our motto is keep more of what you earn.
So let's get into today's episode.
How's it going, everyone?
Welcome back to the How to Lower Your Tax Bill podcast.
This week, we are diving into a topic for business owners.
We're going to focus on two different strategies to implement related to business owners.
And then we'll have two more on our next episode.
Last week, we talked about mostly small businesses as it relates to how they treat auto deductions,
their home office, meals and travel.
So go check that out if you have questions or thoughts on those areas.
This week, we're going to look at two important topics.
One is called the Qualified Business Income Deduction, or QBI for short.
And then you also have the Passed Through Entity Tax, PTET for short.
If you keep up, we'll use those two acronyms just to make it less wordy.
So you have QBI, Qualified Business Income Deduction, and then you have the PTET, or
Passed Through Entity Tax.
The Passed Through Entity Tax came into existence after the Jobs and Tax Cut Act of 2017.
So starting the tax year 2018, they go through the end of 2025.
And so what these two provisions basically spell out is on the QBI deduction, this is
centered around passed through entities.
So if you own a proprietorship, a partnership or an S corporation, that business doesn't
actually pay taxes except in very limited situations.
But that entity doesn't pay taxes.
You as the owner of that entity pays the taxes.
So whatever profits the business has passes through to you on your individual 1040 tax
return.
And so in 2017, one of the objectives of that Jobs and Tax Cut Act was to provide a tax
deduction for big corporations.
At the time, the top tax rate for those corporations was 35%.
That is now 21%.
And so the thought was, well, if you're going to give Apple Corporation a tax break, how
are you not going to give a tax break to the little guy, to the small business owner?
And so that's where the QBI deduction comes into play.
And so the QBI deduction essentially says, if you have qualified business income, which
is generally the active operational income that you make in the business, it doesn't
really factor in items that they would call separately stated.
So interest, capital gains, dividends, those aren't going to be included in your actual
QBI calculation.
It's really going to be the actual operating profit of the business.
So based on the type of business that you own and how much profit and income you have,
you can get up to a 20% tax deduction on that qualified business income.
For easy math, if you have a hundred thousand dollar profit in your S corporation, you're
going to have a K1 that's going to show you made a hundred thousand in profit.
But when you file your tax return, you're only going to pay tax on 80,000 of that profit.
So 20% or $20,000 in this case, you're not going to have to pay taxes on.
So that's actually a very powerful deduction that has allowed small business owners to
actually reduce their tax bill quite a bit, specifically if you have a nice size profit.
Okay.
Now there's two main things to keep in mind with this deduction.
One of them is going to be related to, are you considered an SSTB, which is short for
a specified service trade or business, or are you a non SSTB business?
Of course, the IRS has to complicate everything.
And so what they call a non SSTB or a specified service trade or business, they're looking
at how do you actually make your money in the business?
They are going to isolate out what they consider businesses that make their money based on
the skill or expertise of the owner.
They've identified 13 main types of businesses.
So I'm going to give you this list.
So if this applies to you, then you potentially could have your QBI deduction lowered from
that 20%.
So they're going to look at accounting, actual science, athletics, consulting, financial
services, health, brokerage services, investing, law, performing arts, trading and dealing
in securities.
Or they just give a blanket view and say, if the income you make is based on a service
that you provide that is based on the reputation or skill of the owner, then you are going
to now be subject to a phase out, which means that if you make quote unquote too much money,
you may not be eligible for this deduction at all.
All right.
Now there's a few people that I would consider in the service industry that aren't applicable
to this.
So if you're an architect or an engineer, maybe you're an independent or you're a real
estate agent or an insurance agent, you're actually considered a non-specified service
trade or business.
So if you're a non-specified trade or business, then you still might have some level of phase
out, but you're going to have a lot more flexibility.
All right.
So I know I mentioned this word phase out.
So generally when it comes to most tax matters, the IRS sort of discriminates against people
when they make a certain amount of money.
If you make over a certain amount of money, and in this case, if you're in higher than
the 24% tax bracket.
So if your income for 2024, if you're single, if it exceeds $241,950, or if you're married
and your income exceeds $483,900, you no longer qualify for this deduction if you are a specified
service trade or business.
So if you make $500,000 as a married person for your adjusted gross income, you no longer
qualify for this deduction.
All right.
Now if you make that amount of money, but you're considered a non-specified service
trade or business, you can still qualify for this deduction, but it just might be lowered.
And so just to make things a little interesting, the IRS introduced this idea that they said,
hey, we don't want to punish people who have a lot of employees or we don't want to punish
people who are investing in property.
All right.
And so they've essentially added this extra component to this QBI deduction that says,
if your income is above that threshold, so the 483, if you're married or 241, if you're
single, if your income is above that threshold, then we still will allow you to get this QBI
deduction, but you're going to have to go through a second test.
So if your pension at home is where you have to turn it from 1.8 speed down to maybe one
speed, but that second test, I'm going to break it down.
So you have 20% of your qualified business income.
All right.
Now, if your income is above that threshold that I just gave you, they're going to say,
you are going to either be limited to 20% of your income, or they're going to now look
at what are half of your wages and you're going to look at half of your wages and you're
going to compare half of your wages against 25% of your wages plus two and a half percent
of your property.
Okay.
So let me just give you kind of a simple example, just with easy straight numbers.
So let's just say, going back to my original example, let's say your qualified business
income was a hundred thousand dollars.
Your QBI deduction would traditionally be 20% or $20,000.
However, if your adjusted gross income is let's say above the threshold because you
have income from other sources or your spouse is a high earner, let's say.
Now they're going to look at say, okay, what wages does the business pay to all of its
staff?
All right.
So let's just say your business pays $200,000 of wages to all of their staff people.
Half of that is a hundred thousand dollars.
So now we got $20,000, which is the original 20% of your qualified business income.
Then we have half of your wages, which is a hundred thousand dollars.
But I also have to compare half of that to 25% of my wages plus two and a half percent
of any property that I have.
All right.
So I'm just going to keep this simple.
We have a hundred thousand of profit.
My normal QBI deduction would be $20,000.
However, if I'm above the threshold, my income as a married person is above 483 and I'm a
specified service trader business, I lose out on that $20,000 deduction.
But if I'm a non specified service trader business and I have salaries that I pay to
my staff, I can now look at those numbers and say, okay, half of my salaries of 200,000
is a hundred thousand.
All right.
And then I have to compare that to 25% of my wages, which 25% of 200,000 is now 50,000
plus two and a half percent of any property that I own.
So let's just say I don't own any property just to make it simple.
So now I say, okay, I have a hundred thousand, which is half my wages versus 25,000.
You're going to take the higher of those two numbers.
The higher number is a hundred thousand.
Okay.
But now we're going to compare that to the 20,000, which is the original QBI deduction.
So in that case, your QBI deduction is going to be the lesser of the 20,000 or the hundred
thousand, which now is going to be 20,000.
Okay.
Now let's just imagine for a second though, your actual profit wasn't a hundred thousand.
Let's just say it was 600,000.
20% of that is now a hundred and 20,000, which is higher than the hundred thousand.
So at this point, your deduction would be the hundred thousand versus the 120.
So you're going to go the lesser of those two numbers and you're going to compare it
to the greater of the other equation.
So obviously in these situations, you're going to have to probably write this out or certainly
work with someone who's qualified so they can make sure that you are applying these
numbers correctly and you're maximizing the deduction.
And it's also important to understand what kind of business are you operating?
Or if you're looking to start a business, is this a QBI business?
Is this a SSTB business or is it a non-SSTB business?
Okay.
Now if you have a non-SSTB business, you might have operations that are service based, but
if your revenue is below $25 million, you just can have more than 10% of it be from
a specified service trader business.
So for example, if you run a store and your store also does consulting, your consulting
income has to be less than 10% of the total revenue for you to be considered a non-specified
trader business as an affiliate.
If it's more than 10%, then you're going to have to be subject to the specified service
trader business rules.
So obviously it's a little bit confusing, but one other area that is important from
a tax strategy standpoint is to look at what they call aggregation.
So if I have my hand in multiple businesses and my income is above the threshold, I now
could potentially aggregate these businesses together to increase my deduction overall.
As long as the businesses that I'm involved in all have more than 50% common ownership.
So let's say I own two different businesses.
They're both non-specified trades or business in two different industries.
Okay.
But they have common ownership.
Me, I own more than 50% of both of them and we share some kind of facility personnel or
accounting system.
So let's just say we have the same payroll provider or we have the same distributor or
whatever the case is.
If we have similar, what they call facilities, personnel or accounting systems, or we're
depending on each other for services or products, then I could actually aggregate my numbers
together.
So in that context, if my income is above the threshold and I have wages in both businesses,
I can add those wages together.
When I add those wages together, it may increase my overall calculation and that might possibly
increase my total deduction.
So if you have multiple businesses, you're going to want to look at this aggregation
to see if it's advantageous for you to do it or it's not advantageous for you to do
it.
Now, what other point to think about is when you're planning your taxes for the next year,
it's important to factor in if you're going to qualify for this deduction or not.
So if you want to look at your tax return from last year, you're going to look at line
13, that's going to tell you what your QBI deduction was.
And if you want to get nerdy and look at the calculation, that's going to be on form 18
8995.
Now, if you were above the threshold, it's going to be able to form 8995A.
It's going to add in that second test, but that's just a simple way to evaluate based
on your income.
If you are, you know, how much of that deduction did you receive?
Now one point for you freelancers, or if you have an opportunity to get 1099 income, that
is one factor that you can look at as far as, or is it better off for you to get paid
as a W-2 employee or as a 1099 contractor?
Because depending on the benefits that are paid to you, that QBI deduction is going to
give you a 20% tax deduction on your profits.
That could mean, hey, for the same business, you're getting taxed at 10, 15, 20, 30, $40,000
less because you're in a QBI business versus as an employee.
All right.
So if you do have an option to be a 1099, that is a calculation you'd at least want
to factor in to determine, are you going to be better off financially doing the W-2 work
versus the 1099?
Okay.
So that is the basics on the QBI deduction.
And so lastly, we're going to wrap up with the PTET tax.
All right.
And so this tax came at the same time in 2018, and this was a workaround for the SALT deduction,
which is basically the state and local income taxes.
If you were used to itemizing your deductions on your tax return, meaning you were adding
up your property taxes, your mortgage interest, your charitable deductions.
Prior to 2018, there wasn't a set cap on the amount of property taxes or state taxes that
you got to deduct.
So if you paid $30,000 of state taxes on your state return, where you had $30,000 of property
taxes, you can get a $30,000 tax deduction on your federal return.
Now, there's a thing called AMT I will get into, but generally you're going to be able
to deduct all the taxes you pay either to your state and state income taxes or for your
property taxes.
All right.
However, the jobs and tax cut act limited this deduction to $10,000 per taxpayer.
And if you follow separately, it's going to be $5,000 per taxpayer.
So if you're single, it's 10,000.
If you're married, it's 10,000.
All right.
This was sort of a workaround because for people who are business owners, pass through
entities, so if you own a partnership or an S corporation and you're in a state that has
income taxes, these states wanted to be able to not have been so isolated or been kind
of singled out because when it comes to population growth, many states look at what are the tax
advantages of living in my state.
So if I have a high property tax and a high state tax and there's no way to get a tax
break for that, these states were going to be at a disadvantage.
So they lobbied to now introduce this PGET election.
There's about 40 states that have enacted laws for this.
The highlight is generally if you will allow your business entity to pay the taxes that
you would normally owe from your business profit to the state on your behalf through
the business, you can get a tax deduction at the federal level.
All right.
So let me just put that in layman's terms.
So let's just say that you live in the state of Georgia and you're a decently high income
earner and Georgia is going to charge you $30,000 of state taxes when you file your
state tax return.
All right.
You can make an election that says, hey, look, I am going to actually pay these state taxes
through the business.
Okay.
So this works really well if you're a solo owner because there's no one else to consider.
So you say, hey, look, that $30,000, I'm going to have to pay it.
But if I pay it, I want to pay it from my business and my business is paying that on
my behalf.
And if they pay it on my behalf, they actually can get a tax deduction for that $30,000.
So instead of me losing out on a $20,000, which is 30,000 minus 10, or if I don't even
itemize that deductions, I lose out on the full $30,000 deduction.
If I pay it through my business and I make this election, I could deduct the tax that
I would have owed to the state as a business expense and actually get a federal tax deduction
for it.
So that's that workaround.
All the states kind of have different ways that they do this.
Some of them provide a tax credit on your state return.
So whenever you file the state return, it's going to show, hey, you have a credit for
the money that you owe the state.
You have a credit because it was paid through your business.
Like the state of Louisiana, for example, they say if you have salary, you're still
going to pay a state taxes on that.
But we're going to exclude any money you got from the business profit.
So we're not going to include that in the calculation of your income.
So they actually can exclude it from your income.
So let's just say your business profit was $100,000.
They'll say, okay, you're going to pay state taxes on your wages, but you're not going
to pay state taxes on your business profit if you make this election.
Okay.
So this is an important election that I see missed for people that are in states that
have income taxes.
And hopefully your state, most of the states have it.
There's a few states out there like Pennsylvania that do have a state tax, but they have not
had a way to file it.
But if your state has this election, it's important to review this with your tax advisor
to make sure you're taking advantage of it, especially if you own a business, a partnership
or an S corporation.
Or if you have partners or you have shareholders in your S corp, having a conversation with
all of them to see if it makes sense for you as the business to make this election.
And then how does that equal out to each individual owner?
So hopefully this was helpful as far as the QBI deduction and the PTET.
And so next time we're going to be talking about the appreciation to give you guys a
quick rundown on that.
And then some general business tax credits that you may or may not qualify for as a business
owner.
So this week we have an interesting tax fact.
We will normally go over some kind of a strange tax case or a weird tax fact.
This week in 1696, England actually taxed windows.
With your homeowner, you had to pay tax based on how many windows your house had.
All right.
So obviously when you're getting taxed on something, people will adjust their behavior.
In this case, they would actually brick up their houses instead of having windows.
They would have to pay tax on it.
So this tax lasted nearly 200 years.
In 1851, they repealed the tax.
But for 160 plus years, you were actually paying taxes and you had windows.
So I'm the third person.
I probably would have had bricks just like the other people.
Well that's it for today's episode.
Thanks for joining in.
And remember, if you're thinking about taxes, keep more of what you earn.