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Hi, everyone.

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This is the How to Lower Your Tax Bill podcast.

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I'm your host, Terrence Hutchins.

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I'm a financial and tax advisor in the Dallas forward area.

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And the goal of this podcast is to help you listeners get educated with different tax

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strategies that you can implement to improve your tax situation immediately.

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In this episode, we'll break down useful tax tips you can use to save money no matter what

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your personal or business income situation.

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Our motto is keep more of what you earn.

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So let's get into today's episode.

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How's it going, everyone?

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Welcome back to the How to Lower Your Tax Bill podcast.

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This week, we are diving into a topic for business owners.

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We're going to focus on two different strategies to implement related to business owners.

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And then we'll have two more on our next episode.

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Last week, we talked about mostly small businesses as it relates to how they treat auto deductions,

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their home office, meals and travel.

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So go check that out if you have questions or thoughts on those areas.

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This week, we're going to look at two important topics.

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One is called the Qualified Business Income Deduction, or QBI for short.

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And then you also have the Passed Through Entity Tax, PTET for short.

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If you keep up, we'll use those two acronyms just to make it less wordy.

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So you have QBI, Qualified Business Income Deduction, and then you have the PTET, or

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Passed Through Entity Tax.

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The Passed Through Entity Tax came into existence after the Jobs and Tax Cut Act of 2017.

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So starting the tax year 2018, they go through the end of 2025.

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And so what these two provisions basically spell out is on the QBI deduction, this is

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centered around passed through entities.

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So if you own a proprietorship, a partnership or an S corporation, that business doesn't

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actually pay taxes except in very limited situations.

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But that entity doesn't pay taxes.

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You as the owner of that entity pays the taxes.

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So whatever profits the business has passes through to you on your individual 1040 tax

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return.

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And so in 2017, one of the objectives of that Jobs and Tax Cut Act was to provide a tax

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deduction for big corporations.

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At the time, the top tax rate for those corporations was 35%.

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That is now 21%.

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And so the thought was, well, if you're going to give Apple Corporation a tax break, how

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are you not going to give a tax break to the little guy, to the small business owner?

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And so that's where the QBI deduction comes into play.

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And so the QBI deduction essentially says, if you have qualified business income, which

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is generally the active operational income that you make in the business, it doesn't

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really factor in items that they would call separately stated.

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So interest, capital gains, dividends, those aren't going to be included in your actual

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QBI calculation.

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It's really going to be the actual operating profit of the business.

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So based on the type of business that you own and how much profit and income you have,

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you can get up to a 20% tax deduction on that qualified business income.

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For easy math, if you have a hundred thousand dollar profit in your S corporation, you're

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going to have a K1 that's going to show you made a hundred thousand in profit.

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But when you file your tax return, you're only going to pay tax on 80,000 of that profit.

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So 20% or $20,000 in this case, you're not going to have to pay taxes on.

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So that's actually a very powerful deduction that has allowed small business owners to

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actually reduce their tax bill quite a bit, specifically if you have a nice size profit.

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Okay.

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Now there's two main things to keep in mind with this deduction.

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One of them is going to be related to, are you considered an SSTB, which is short for

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a specified service trade or business, or are you a non SSTB business?

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Of course, the IRS has to complicate everything.

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And so what they call a non SSTB or a specified service trade or business, they're looking

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at how do you actually make your money in the business?

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They are going to isolate out what they consider businesses that make their money based on

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the skill or expertise of the owner.

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They've identified 13 main types of businesses.

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So I'm going to give you this list.

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So if this applies to you, then you potentially could have your QBI deduction lowered from

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that 20%.

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So they're going to look at accounting, actual science, athletics, consulting, financial

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services, health, brokerage services, investing, law, performing arts, trading and dealing

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in securities.

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Or they just give a blanket view and say, if the income you make is based on a service

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that you provide that is based on the reputation or skill of the owner, then you are going

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to now be subject to a phase out, which means that if you make quote unquote too much money,

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you may not be eligible for this deduction at all.

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All right.

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Now there's a few people that I would consider in the service industry that aren't applicable

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to this.

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So if you're an architect or an engineer, maybe you're an independent or you're a real

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estate agent or an insurance agent, you're actually considered a non-specified service

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trade or business.

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So if you're a non-specified trade or business, then you still might have some level of phase

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out, but you're going to have a lot more flexibility.

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All right.

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So I know I mentioned this word phase out.

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So generally when it comes to most tax matters, the IRS sort of discriminates against people

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when they make a certain amount of money.

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If you make over a certain amount of money, and in this case, if you're in higher than

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the 24% tax bracket.

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So if your income for 2024, if you're single, if it exceeds $241,950, or if you're married

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and your income exceeds $483,900, you no longer qualify for this deduction if you are a specified

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service trade or business.

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So if you make $500,000 as a married person for your adjusted gross income, you no longer

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qualify for this deduction.

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All right.

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Now if you make that amount of money, but you're considered a non-specified service

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trade or business, you can still qualify for this deduction, but it just might be lowered.

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And so just to make things a little interesting, the IRS introduced this idea that they said,

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hey, we don't want to punish people who have a lot of employees or we don't want to punish

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people who are investing in property.

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All right.

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And so they've essentially added this extra component to this QBI deduction that says,

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if your income is above that threshold, so the 483, if you're married or 241, if you're

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single, if your income is above that threshold, then we still will allow you to get this QBI

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deduction, but you're going to have to go through a second test.

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So if your pension at home is where you have to turn it from 1.8 speed down to maybe one

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speed, but that second test, I'm going to break it down.

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So you have 20% of your qualified business income.

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All right.

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Now, if your income is above that threshold that I just gave you, they're going to say,

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you are going to either be limited to 20% of your income, or they're going to now look

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at what are half of your wages and you're going to look at half of your wages and you're

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going to compare half of your wages against 25% of your wages plus two and a half percent

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of your property.

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Okay.

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So let me just give you kind of a simple example, just with easy straight numbers.

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So let's just say, going back to my original example, let's say your qualified business

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income was a hundred thousand dollars.

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Your QBI deduction would traditionally be 20% or $20,000.

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However, if your adjusted gross income is let's say above the threshold because you

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have income from other sources or your spouse is a high earner, let's say.

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Now they're going to look at say, okay, what wages does the business pay to all of its

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staff?

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All right.

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So let's just say your business pays $200,000 of wages to all of their staff people.

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Half of that is a hundred thousand dollars.

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So now we got $20,000, which is the original 20% of your qualified business income.

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Then we have half of your wages, which is a hundred thousand dollars.

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But I also have to compare half of that to 25% of my wages plus two and a half percent

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of any property that I have.

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All right.

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So I'm just going to keep this simple.

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We have a hundred thousand of profit.

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My normal QBI deduction would be $20,000.

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However, if I'm above the threshold, my income as a married person is above 483 and I'm a

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specified service trader business, I lose out on that $20,000 deduction.

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But if I'm a non specified service trader business and I have salaries that I pay to

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my staff, I can now look at those numbers and say, okay, half of my salaries of 200,000

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is a hundred thousand.

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All right.

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And then I have to compare that to 25% of my wages, which 25% of 200,000 is now 50,000

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plus two and a half percent of any property that I own.

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So let's just say I don't own any property just to make it simple.

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So now I say, okay, I have a hundred thousand, which is half my wages versus 25,000.

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You're going to take the higher of those two numbers.

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The higher number is a hundred thousand.

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Okay.

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But now we're going to compare that to the 20,000, which is the original QBI deduction.

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So in that case, your QBI deduction is going to be the lesser of the 20,000 or the hundred

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thousand, which now is going to be 20,000.

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Okay.

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Now let's just imagine for a second though, your actual profit wasn't a hundred thousand.

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Let's just say it was 600,000.

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20% of that is now a hundred and 20,000, which is higher than the hundred thousand.

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So at this point, your deduction would be the hundred thousand versus the 120.

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So you're going to go the lesser of those two numbers and you're going to compare it

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to the greater of the other equation.

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So obviously in these situations, you're going to have to probably write this out or certainly

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work with someone who's qualified so they can make sure that you are applying these

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numbers correctly and you're maximizing the deduction.

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And it's also important to understand what kind of business are you operating?

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Or if you're looking to start a business, is this a QBI business?

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Is this a SSTB business or is it a non-SSTB business?

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Okay.

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Now if you have a non-SSTB business, you might have operations that are service based, but

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if your revenue is below $25 million, you just can have more than 10% of it be from

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a specified service trader business.

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So for example, if you run a store and your store also does consulting, your consulting

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income has to be less than 10% of the total revenue for you to be considered a non-specified

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trader business as an affiliate.

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If it's more than 10%, then you're going to have to be subject to the specified service

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trader business rules.

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So obviously it's a little bit confusing, but one other area that is important from

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a tax strategy standpoint is to look at what they call aggregation.

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So if I have my hand in multiple businesses and my income is above the threshold, I now

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could potentially aggregate these businesses together to increase my deduction overall.

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As long as the businesses that I'm involved in all have more than 50% common ownership.

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So let's say I own two different businesses.

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They're both non-specified trades or business in two different industries.

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Okay.

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But they have common ownership.

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Me, I own more than 50% of both of them and we share some kind of facility personnel or

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accounting system.

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So let's just say we have the same payroll provider or we have the same distributor or

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whatever the case is.

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If we have similar, what they call facilities, personnel or accounting systems, or we're

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depending on each other for services or products, then I could actually aggregate my numbers

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together.

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So in that context, if my income is above the threshold and I have wages in both businesses,

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I can add those wages together.

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When I add those wages together, it may increase my overall calculation and that might possibly

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increase my total deduction.

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So if you have multiple businesses, you're going to want to look at this aggregation

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to see if it's advantageous for you to do it or it's not advantageous for you to do

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it.

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Now, what other point to think about is when you're planning your taxes for the next year,

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it's important to factor in if you're going to qualify for this deduction or not.

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So if you want to look at your tax return from last year, you're going to look at line

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13, that's going to tell you what your QBI deduction was.

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And if you want to get nerdy and look at the calculation, that's going to be on form 18

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8995.

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Now, if you were above the threshold, it's going to be able to form 8995A.

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It's going to add in that second test, but that's just a simple way to evaluate based

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on your income.

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If you are, you know, how much of that deduction did you receive?

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Now one point for you freelancers, or if you have an opportunity to get 1099 income, that

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is one factor that you can look at as far as, or is it better off for you to get paid

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as a W-2 employee or as a 1099 contractor?

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Because depending on the benefits that are paid to you, that QBI deduction is going to

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give you a 20% tax deduction on your profits.

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That could mean, hey, for the same business, you're getting taxed at 10, 15, 20, 30, $40,000

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less because you're in a QBI business versus as an employee.

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All right.

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So if you do have an option to be a 1099, that is a calculation you'd at least want

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to factor in to determine, are you going to be better off financially doing the W-2 work

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versus the 1099?

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Okay.

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So that is the basics on the QBI deduction.

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And so lastly, we're going to wrap up with the PTET tax.

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All right.

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And so this tax came at the same time in 2018, and this was a workaround for the SALT deduction,

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which is basically the state and local income taxes.

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If you were used to itemizing your deductions on your tax return, meaning you were adding

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up your property taxes, your mortgage interest, your charitable deductions.

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Prior to 2018, there wasn't a set cap on the amount of property taxes or state taxes that

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you got to deduct.

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So if you paid $30,000 of state taxes on your state return, where you had $30,000 of property

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taxes, you can get a $30,000 tax deduction on your federal return.

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Now, there's a thing called AMT I will get into, but generally you're going to be able

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to deduct all the taxes you pay either to your state and state income taxes or for your

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property taxes.

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All right.

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However, the jobs and tax cut act limited this deduction to $10,000 per taxpayer.

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And if you follow separately, it's going to be $5,000 per taxpayer.

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So if you're single, it's 10,000.

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If you're married, it's 10,000.

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All right.

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This was sort of a workaround because for people who are business owners, pass through

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entities, so if you own a partnership or an S corporation and you're in a state that has

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income taxes, these states wanted to be able to not have been so isolated or been kind

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of singled out because when it comes to population growth, many states look at what are the tax

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advantages of living in my state.

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So if I have a high property tax and a high state tax and there's no way to get a tax

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break for that, these states were going to be at a disadvantage.

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So they lobbied to now introduce this PGET election.

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There's about 40 states that have enacted laws for this.

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The highlight is generally if you will allow your business entity to pay the taxes that

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you would normally owe from your business profit to the state on your behalf through

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the business, you can get a tax deduction at the federal level.

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All right.

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So let me just put that in layman's terms.

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So let's just say that you live in the state of Georgia and you're a decently high income

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earner and Georgia is going to charge you $30,000 of state taxes when you file your

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state tax return.

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All right.

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You can make an election that says, hey, look, I am going to actually pay these state taxes

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through the business.

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Okay.

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So this works really well if you're a solo owner because there's no one else to consider.

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So you say, hey, look, that $30,000, I'm going to have to pay it.

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But if I pay it, I want to pay it from my business and my business is paying that on

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my behalf.

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And if they pay it on my behalf, they actually can get a tax deduction for that $30,000.

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So instead of me losing out on a $20,000, which is 30,000 minus 10, or if I don't even

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itemize that deductions, I lose out on the full $30,000 deduction.

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If I pay it through my business and I make this election, I could deduct the tax that

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I would have owed to the state as a business expense and actually get a federal tax deduction

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for it.

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So that's that workaround.

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All the states kind of have different ways that they do this.

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Some of them provide a tax credit on your state return.

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So whenever you file the state return, it's going to show, hey, you have a credit for

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the money that you owe the state.

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You have a credit because it was paid through your business.

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Like the state of Louisiana, for example, they say if you have salary, you're still

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going to pay a state taxes on that.

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But we're going to exclude any money you got from the business profit.

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So we're not going to include that in the calculation of your income.

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So they actually can exclude it from your income.

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So let's just say your business profit was $100,000.

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They'll say, okay, you're going to pay state taxes on your wages, but you're not going

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to pay state taxes on your business profit if you make this election.

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Okay.

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So this is an important election that I see missed for people that are in states that

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have income taxes.

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And hopefully your state, most of the states have it.

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There's a few states out there like Pennsylvania that do have a state tax, but they have not

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had a way to file it.

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But if your state has this election, it's important to review this with your tax advisor

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to make sure you're taking advantage of it, especially if you own a business, a partnership

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or an S corporation.

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Or if you have partners or you have shareholders in your S corp, having a conversation with

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all of them to see if it makes sense for you as the business to make this election.

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And then how does that equal out to each individual owner?

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So hopefully this was helpful as far as the QBI deduction and the PTET.

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And so next time we're going to be talking about the appreciation to give you guys a

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quick rundown on that.

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And then some general business tax credits that you may or may not qualify for as a business

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owner.

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So this week we have an interesting tax fact.

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We will normally go over some kind of a strange tax case or a weird tax fact.

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This week in 1696, England actually taxed windows.

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With your homeowner, you had to pay tax based on how many windows your house had.

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All right.

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So obviously when you're getting taxed on something, people will adjust their behavior.

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In this case, they would actually brick up their houses instead of having windows.

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They would have to pay tax on it.

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So this tax lasted nearly 200 years.

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In 1851, they repealed the tax.

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But for 160 plus years, you were actually paying taxes and you had windows.

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So I'm the third person.

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I probably would have had bricks just like the other people.

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Well that's it for today's episode.

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Thanks for joining in.

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And remember, if you're thinking about taxes, keep more of what you earn.