If you are a high-income professional who is excluded from the new pass-through deduction because you are in a specified service trade or business (SSTB), you may be able to use retirement plan contributions as a work-around so that you can benefit from that new 20% deduction.
An SSTB generally includes the following trades or businesses:
- Health (services by physicians, nurses, dentists, veterinarians, and other similar health care providers, although this does not apply to spas and health clubs)
- Actuarial science
- Performing arts (but this does not apply to the services of others in the industry, such as promoters and broadcasters);
- Financial services
The new deduction includes limits based upon an individual’s taxable income. For individuals in SSTBs, these limitations do not kick in as long the taxpayer’s taxable income is below the phase-out threshold. For SSTBs, the deduction phases out if your taxable income is between $315,000 and $415,000 for married couples filing jointly and between $157,500 and $207,500 for other filing statuses. Thus, once your taxable income is more than the $415,000 or $207,500 level, there is no 199A deduction based on income from the SSTB.
One way to reduce taxable income is by contributing to deductible retirement plans. But IRAs won’t cut it because they can only shelter $5,500 ($6,500 for those age 50 or older), plus their deductibility is phased out for higher-income taxpayers.
Better choices include defined contribution plans such as a self-employed retirement plan or a simplified employee plan (SEP), which allows a deductible contribution of 25% of your business’s net profit, but capped at $55,000 (2018). These may help for some, but you may need to contribute a lot more to get below the deduction phase-out threshold.
Another alternative is a defined benefit plan, which provides for a fixed benefit at retirement. The contribution amounts are calculated to meet that benefit goal based on the participant’s age and the annual retirement benefit desired. The maximum annual benefit for an individual beginning retirement at age 65 is $220,000. Thus, depending upon the selected benefit and the individual’s age, the annual deductible contribution could be six figures and would provide a substantial reduction in taxable income that could help you qualify for the 20% pass-through deduction. However, defined benefit plans cost a substantial amount to establish and maintain, which needs to be considered.
There are also other tax benefits. For instance, any reduction in taxable income also reduces your income tax liability, and those using this strategy are in the 32% or higher tax bracket, so any reduction in taxable income will generally save 32% of the amount contributed to the retirement plan, in addition to whatever benefit is gained from the 20% pass-through deduction.
As you can see, this is a complicated strategy, and there is a lot to be considered, but the benefits can be substantial. Please call for an appointment to determine in greater detail the types of retirement plans available to you and how this strategy will impact your tax liability.
Have a tax question? Contact Charles Woodson.
Author: Chuck Woodson is the Leading Expert and Fiduciary Coach to families dealing with trusts and estates. Contact me to handle all trust and estate matters seamlessly for you.