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How You May be Eligible for Tax Reform's New Qualified Business Income Deduction

April 10, 2018

The Tax Cuts and Jobs Act of 2017 is a boon for American business, and it will save most of us money on our individual tax returns as well. The most befuddling aspect of tax reform, however, is that it discriminates against doctors, lawyers and CPAs – that is us professionals!

It does this by limiting the juicy new "qualified business income" (QBI) tax deduction for "pass-through" businesses (S corporations, partnerships and sole proprietorships) to non-professionals. Apparently, the tax law writers decided that opening up the deduction to all businesses would blow too big a hole in the federal budget.

But, before writing this off, understand that there are three scenarios where, despite your professional status, you can still take advantage of the QBI deduction.

How does the QBI deduction work?

First, some background. As you're probably well aware, the corporate tax rate (for traditional C corporations) has been slashed from 35% to 21%. To equalize the tax benefits for the majority of small pass-through business entities, the new law introduces the so-called "QBI deduction."

In general, it works like this. The QBI deduction that the individual business owner will claim on his or her 1040 income tax return will equal 20% of qualified business income (company profit) (but subject to certain important limitations).

So, if the owner of a general, non-professional, business earns a profit of $100,000, he or she can claim a brand new $20,000 tax deduction. If he or she is in the highest 37% tax rate, that will save $7,400 in tax. That's a tremendous gift!

Here are the three possible ways dentists can take advantage of the QBI Deduction:

1. If your taxable income is $315,000 or less ($157,500 if single) being a professional is a non-issue. That prohibition is ignored in this case. Your tax deduction will be the LESSER of (a) 20% of your QBI, or (b) 20% of your taxable income.

Associate employees are not business owners and aren’t eligible for the QBI deduction. But, if they form a pass through business like an LLC and switch their status from employee to independent contractor, then they can become eligible too. (The employer will need to consent to this, of course, and this may take some persuading.)

2. If your taxable income is above $415,000 or ($207,500 if single), then you cannot claim the QBI deduction. If it is between $315,000 and $415,000 (or $157,500 and $207,500 if single), then your ability to claim the deduction is phasing out. So, if your taxable income is within striking distance of $415,000/$207,500, look for ways to bring it down. For example, if you purchase needed equipment, remodel or build out a new office, or implement a new retirement plan, you will reduce your taxes and may qualify for the QBI deduction.

3. High earning dentists should consider forming their own dental support organization, or DSO. The DSO does not practice clinical dentistry so would not be prohibited from claiming the QBI deduction. Pursuant to an agreement between your practice and your DSO, the DSO will provide business services to your dental practice for a large annual fee. The DSO must do real work and employ real people. Your clinical employees would be employed by your dental practice, and your front desk, officer manager and other business employees would be employed by the DSO.

As the DSO owner, you would claim the QBI deduction based on the qualified business income of the DSO. The deduction will equal the LESSER of (a) 20% the QBI generated by the DSO, or (b) 50% of the W-2 wages paid to the DSO’s employees. If, for example, the dental practice pays the DSO $1,000,000 for its services, the company W-2’s total $400,000 and the QBI equals $600,000, then the owner’s QBI deduction will equal $120,000, which is the lesser of 20% of $600,000 and 50% of $400,000. This is a huge tax savings of $44,400 for someone in the 37% tax bracket. 

Stay On Top of Changing Tax Laws and Dental Practice Management

A good financial advisor puts you and your practice first, making recommendations with you in mind. As trusted advisors for the dental profession, Collier & Associates prides itself on delivering expert advice on these topics and more in our twice monthly C&A Newsletter. Learn more about the Newsletter and receive the first three issues of the Newsletter for 2018. Together, these comprise our special Tax Reform Guide for Dentists.

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