What type of taxpayer are you? Do you meet with your tax advisor prior to the end of the year and strategize, or are you more “let the chips fall where they may”? This may be the year where tax planning and using a retirement plan could pay off when it comes to tax savings.
How is this year different? The new tax law known as the TCJA (Tax Cut and Jobs Act) created a new deduction for certain businesses known as Section 199A a.k.a. the qualified business income (QBI) deduction. It reduces your taxable income, which means less tax.
Businesses able to claim this deduction include pass-through entities such as S Corporations, partnerships and sole proprietorships. The deduction can be up to 20% of your QBI. If you are a service business, the QBI deduction will not be available if your taxable income exceeds the threshold amount $157,500 ($315,000 in the case of a joint return). If your taxable income is between $315,000 and $415,000, your QBI deduction is phased out. Once your taxable income is over $415,000, you won’t qualify for the deduction. Remember these limitations apply to a service business.
The tax consequences of having additional income that puts you above this threshold amount could be quite costly. One way to reduce your taxable income is through funding a retirement plan. In addition to reducing your taxable income to qualify for this new deduction, there are other benefits to funding a retirement plan:
- A retirement plan has several advantages including: putting away money tax deferred and allowing it to grow without paying current taxes on the earnings.
- The government will help you fund your contribution by decreasing your taxes. With the additional tax savings, you may be able to put away more money.
- Another advantage is retirement money in a qualified retirement plan can be protected from certain creditors.
- Furthermore, earnings within the fund are not taxed until the money is withdrawn from the retirement plan.
- Most likely you may be in higher tax bracket when you fund the retirement plan and in a lower tax bracket when you withdraw the funds during retirement. This would make for a winning combination.
The benefits of saving for retirement are many and using the retirement plan to reduce your taxable income to take advantage of the new tax law will be an additional benefit.
Stephen Tellez, CPA