December 5, 2019
Self-employed physicians, like many other business owners, are well into their second tax season following the principles outlined in the Tax Cuts and Jobs Act (TCJA). The qualified business income deduction (QBI deduction) – also known as Section 199A – continues to play an important role in year-end planning discussions. As the year ends, it is a good time to revise prior year’s QBI deduction strategies. As part of the year-end planning process, it’s important to determine whether the recently released regulations provide new information that can influence 199A deduction decisions moving forward. In addition, it’s important to review opportunities to leverage the deduction for additional savings. To help clients, prospects and others, Wilson Lewis has provided insight into potential saving opportunities for Atlanta physicians below.
Guaranteed payments and distributions are two ways partnerships can compensate their physician-partners, but they are treated differently under Section 199A. Guaranteed payments are valid business expenses that reduce business income, and distributions are a return of profits that do not reduce business income. Because the 20% deduction is based on business income, compensating physicians with distributions will produce a larger potential QBI deduction. Let’s look at an example:
Example:
Physician Group 1 (PG1) and Physician Group 2 (PG2) both generate profits of $500,000. PG1 pays its partners $200,000 of guaranteed payments, while PG2 pays its partners $200,000 using distributions. PG1’s potential QBI deduction will be $60,000 while PG2’s will be $100,000.
| PG1 | PG2 | |
| Business Revenues | $500,000 | $500,000 |
| Less: Guaranteed Payments | $200,000 | $0 |
| Qualified Business Income | $300,000 | $500,000 |
| X 20% | X 20% | X 20% |
| Potential Deduction | $60,000 | $100,000 |
Although the partners receive the same compensation – $200,000 – PG2’s partners are eligible for a larger QBI deduction. This technique is not foolproof, though. To pay physicians for their services without using guaranteed payments, the practice might need to revisit the partnership agreement and set up special allocations.
Most physicians are barred from contributing to a ROTH IRA; their incomes are too high. In 2019, single filers with AGIs of $137,000 and married filers with AGIs of $203,000 exceed ROTH IRA limits. The only way high-earning individuals can contribute to ROTH IRAs is if they first contribute to traditional IRAs, convert those accounts to ROTHs, then pay taxes on the conversion. These “backdoor ROTHs” have always been an option, but the tax savings promised with the QBI deduction can make a costly conversion more palatable.
Physicians should always check with their providers to make sure backdoor ROTHs are sensible. Tax rates for middle- and upper-class taxpayers are at a record low, so it will make sense for many to pay taxes on retirement contributions now. But taxpayers who plan to be in a lower tax bracket in retirement may be better off sticking with a traditional IRA. Taxpayers must also keep an eye on their income; backdoor ROTHs increase taxable income and can bump taxpayers above the QBI income threshold, causing them to lose their deduction altogether. As always, look at your tax situation holistically before moving forward with any strategy.
Some physicians own rental businesses that lease office buildings directly to their medical practices. IRS regulations state that self-rentals are considered trades or businesses when there is common ownership between the rental activity and the other business. For specified service trades or businesses (SSTBs) – like medical practices – this common ownership safe harbor is 50%. To put it differently, if there is at least 50% common ownership between an SSTB and a rental business, the rental business is eligible for the QBI deduction.
Even though self-rentals made to an SSTB are eligible for the QBI deduction, they may also be subject to Section 199A’s strict SSTB limitations. Self-rental income received from a related SSTB will be reclassified as SSTB income. Non-self-rental income will not be subject to those same limitations and can qualify for the QBI deduction under typical income limitations.
This 50% ownership safe harbor makes it easier for physicians to know when their rental activities qualify for the QBI deduction. If their rental activities do not have at least 50% common ownership with their SSTB, their rental activity may still qualify for the QBI deduction. Click here to read more about how rental businesses qualify for the QBI deduction irrespective of self-rental circumstances.
If any of these talking points sparked your interest, bring them up with your tax practitioner before the end of the year. The QBI deduction is only available through the year 2025, so it’s best to optimize the deduction now while you can. If you have questions about leveraging the QBI deduction or need assistance with a tax planning issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.