Last October, I wrote about a handful of specific definitions of the Qualified Business Income Deduction (QBID) as they applied to dentists. Given the law’s restrictions on type of business and income threshold, we already know that some dentists won’t qualify. But there are enough who will benefit a little all the way up to receiving the full deduction. Recall that the deduction provides up to a 20 percent tax deduction for qualified small businesses, including some dental practices.
The IRS recently released clarifications about how it works, and especially considering year-end tax planning, I thought it would make sense to revisit this.
In 2019, the deduction begins to phase out at $315,000 for married filing jointly and $157,500 for everyone else, and after $415,000 and $207,500 for married filing jointly and all other filers, respectively, there is no benefit. However, even if your income disqualifies you from all or part of the deduction, you can still possibly take advantage of the real estate component. According to the IRS, “The QBI deduction is limited to the lesser of 20% of QBI plus 20% of qualified real estate investment trust (REIT) dividends…” REITs are companies that own and usually also operate income-producing commercial real estate, like the office building where your practice is located, for example.
If your dental practice is located in an office building with other tenants, and you own the building, the rental real estate activity qualifies for QBID – regardless of your income level. To qualify, you must be actively involved in the rental property to the tune of 250 hours per year, and the REIT cannot be a C corporation.
The rent payments from your practice could also qualify, if it’s a situation where the rent payments are going to a rental property that you also own. Self-rentals could meet a safe harbor requirement if at least 50 percent of rental income comes from non-SSTB businesses. That means business likes yours that the IRS calls ‘Specified Service Trade or Business’ where services are provided and the principal asset is the reputation or skill of owners or employees. In other words, dentists, physicians, lawyers, accountants, financial planners, etc.
Let’s say you own the commercial building where your practice is located, and there are two other tenants. One is a small legal practice and the other is an unrelated business entity. The legal practice’s rental income combined with your dental practice equals 70 percent of the total rent. Only the remaining 30 percent would be classified as non-SSTB income and therefore not limited by income thresholds and other restrictions imposed on service businesses like yours.
Don’t own the real estate that your practice is in? Now is an excellent time to consider it. Not only is there the obvious and new benefit of the QBI deduction, but also real estate is known to be a great source of passive income. And when you eventually sell your practice, you can decide whether to sell the real estate with it, or continue operating as the landlord to receive tenant rental payments. It’s not a bad deal either way you look at it.
As I mentioned in my previous blog about QBID, if your income is hovering right around the level where the deduction begins to phase out or is phased out entirely, some tactics you and your CPA can consider before year-end are:
- Increasing contributions to retirement plans and/or charity to reduce your taxable income
- Ensuring you’re maxing out all available business deductions for your practice, even though many were cut back as a result of the Tax Cuts and Jobs Act; and
- Utilizing accelerated depreciation on big ticket items you would be purchasing next year anyway.
There are some other tactics I mentioned in my blog post from last year that still hold true.
Other updates to QBID you should be aware of are that above-the-line deductions for self-employment tax, self-employed health insurance deduction, and self-employed retirement deduction should be removed from qualified business income, for purposes of claiming the deduction. Further, if you decide to carry forward any losses to reduce your income this year, those losses will be treated as reducing your qualified business income for 2020.
If you’re wondering about how much of the QBID you qualify for, whether you have real estate in the equation or not, call my office to discuss your options before the end of 2019.