By Jamie Hopkins at Forbes on February 20, 2019
The Tax Cuts and Jobs Act made a lot of changes in the realms of corporate, business, and individual federal taxes while leaving retirement planning taxes and laws relatively unchanged. But that does not mean retirement planning decisions and strategies are exactly the same as they were two years ago. Lower taxes for some could allow them to save more or consider other investment strategies.
With businesses, the TCJA created a significant tax deduction for pass-through business owners (including self-employed taxpayers who report their business activities on Schedule C) called the “199A deduction.” This deduction – perhaps one of the most complex in the TCJA – should modify how some business owners save for retirement. Let’s take a look at a few ways the 199A deduction changed the conversation around retirement savings.
1. Use Plan Deductible Contributions to Qualify for 199A
In order to qualify for the full 20 percent of qualified business income 199A deduction, the business owner needs to meet certain qualifications. (To see more on the details of 199A read this <a href="https://www.forbes.com/sites/anthonynitti/2019/01/19/irs-publishes-final-guidance-on-the-20-pass-through-deduction-putting-it-all-together/#2eb7045bd9f0" target="_self" data-ga-track="InternalLink:https://www.forbes.com/sites/anthonynitti/2019/01/19/irs-publishes-final-guidance-on-the-20-pass-through-deduction-putting-it-all-together/#2eb7045bd9f0">Forbes article.) The deduction can be completely lost or limited due to income limitations. For specified service businesses, like consultants and financial advisors, etc., the deduction can phased-out based on your taxable income and will be completely lost if your taxable income exceeds the upper end of the phase-out limitations. For non-specified service businesses, the deduction could still be lost due to a phase-in of a potential limitation based on taxable income. (For more on the limitations and specified service business rules read this <a href="https://www.forbes.com/sites/jamiehopkins/2019/02/13/understanding-the-199a-deduction-after-the-new-irs-final-regulations/#e18d87357709" target="_self" data-ga-track="InternalLink:https://www.forbes.com/sites/jamiehopkins/2019/02/13/understanding-the-199a-deduction-after-the-new-irs-final-regulations/#e18d87357709">Forbes article).
The income-based limitations are as follows:
$157,500 to $207,500 (2018)
$160,700 to $210,700 (2019)
Married Filing Jointly
$ 315,000 to $415,000 (2018)
$ 321,450 to $421,450 (2019)
So, if your taxable income exceeds the thresholds and your 199A deduction is limited or lost, one strategy to maximize the deduction is to bring taxable income down below the thresholds. One way to do this is to contribute to a retirement account. For instance, contributions to a 401(k), SEP IRA, SIMPLE IRA, deductible traditional, IRA, HSA, or defined benefit plan can be deductible from taxable income. This can allow you to save for retirement, lower your current tax bill, and qualify for the 199A deduction.
For example, let’s say you were a sole-proprietorship and did consulting, with projected taxable income of $210,000 in 2018. At this level, you would be completely phased out of any 199A deduction as a specified-service business and single filer.
However, if you could drop your taxable income below the $157,500 limit, you could take a 20 percent deduction on all of your remaining qualified business income, which could lower your tax bill by thousands. If you had a solo 401(k), you could likely put away $54,000 by doing both employer and employee contributions, allowing you to drop below the phase-out limitation and get the full deduction on QBI.
If your income is well above the 199A thresholds, you could consider using a defined benefit plan for a larger deduction. In the right situation, you can set aside over $200,000 a year for retirement and deduct it from your taxable income by using a defined benefit plan. Still, this plan isn’t for everyone as it requires a lot of cash flow and funding.
In some cases, you can piece together multiple deductions to help lower your taxable income and save for retirement at the same time. For instance, you can max out your 401(k) and also use a defined benefit plan to save for retirement. Or you could use a SIMPLE or SEP and also contribute to an IRA to reduce your taxable income.
Furthermore, if you are in a high deductible plan, you could contribute up to $3,450 to an HSA for a single individual and $6,900 for a qualifying family in 2018.
Retirement plans offer a great way to set aside money for retirement and lower your tax bill today. But with 199A on the books, retirement savings could also help lower your taxable income, so you qualify for a larger 199A deduction.