Unlocking Year-End Tax Opportunities: Boost Your Section 199A Deduction!

As the tax year draws close, now is the ideal time to evaluate strategies that maximize your benefits, including the often-overlooked Section 199A deduction. Without careful planning, you might miss opportunities to enhance this valuable deduction, potentially leaving significant tax savings untapped.

For taxpayers with incomes above $182,100 (or $364,200 for joint filers), multiple factors—such as your business type, wages paid, and property ownership—can affect your Section 199A deduction. If your deduction isn’t hitting the full 20% of your qualified business income (QBI), here are three strategic actions that may help you reduce your income taxes and maximize this deduction.

Strategy 1: Harvest Capital Losses

Capital gains increase your taxable income, impacting both your eligibility for and the amount of your Section 199A deduction. If recent capital gains push you above eligibility thresholds or capping your deduction, consider harvesting capital losses to offset these gains. You can lower your taxable income and improve your Section 199A deduction by strategically selling underperforming investments at a loss before year-end.

Strategy 2: Make Charitable Contributions

Making charitable contributions before the end of the year supports causes you care about and can lower your taxable income through itemized deductions. By reducing your adjusted gross income with these deductions, you may qualify for a larger Section 199A deduction. Charitable giving can efficiently mitigate threshold issues, especially if you’re close to the income limits that reduce your deduction.

Strategy 3: Acquire Business Assets

Purchasing business assets before December 31 can be a powerful tactic. With Section 179 expensing, you can deduct 100% of qualifying equipment and property. Bonus depreciation and MACRS allow up to 80% write-offs on certain purchases. By putting these assets into service before the end of the year, you can reduce your taxable income and elevate your Section 199A deduction.

Major business asset purchases can benefit you in two ways:

1. Reducing Taxable Income: Lowering your taxable income may allow you to qualify for a larger Section 199A deduction if it brings you under the income threshold.
2. Increasing Qualified Property Basis: The Section 199A deduction calculation considers 2.5% of the unadjusted basis in your business’s qualified property. Acquiring new assets increases this basis, which can further boost your deduction.

Understanding Qualified Business Income (QBI)

What Constitutes QBI?

Qualified Business Income (QBI) is net income earned from a domestic business organized as a pass-through entity. This includes income from sole proprietorships, partnerships, S corporations, or LLCs. QBI includes active income from business operations within the U.S. Eligible income may include profits from consulting, rentals, or retail businesses.

• Types of Income That Qualify: QBI covers income, gains, deductions, and losses from U.S.-based businesses. Eligible income includes profits from a store, rental properties, or freelance consulting work.
• Types of Income That Don’t Qualify: QBI excludes investment income like capital gains, interest, and dividends. It also doesn’t include reasonable compensation or guaranteed payments to partners.

Calculating QBI

To calculate QBI, determine net income from eligible activities and apply qualified deductions.

• Step-by-Step Calculation:
  1. Start with Total Business Income: Begin with total income from eligible business activities.
  2. Subtract Qualified Deductions: Deduct expenses like rent, salaries, utilities, and supplies from total income.
  3. Adjust for SSTBs: If your business is an SSTB, deduction limits apply if income exceeds IRS thresholds.
  4. Calculate the Deduction: Multiply the adjusted QBI by 20% to get the eligible deduction amount.

This process results in the QBI amount eligible for the Section 199A deduction.

Section 199A Deduction Limitations and Phase-Outs

Thresholds and Phase-Outs

The Section 199A deduction includes income thresholds affecting eligibility and deduction amounts. For 2023, phase-out begins at:

• Single Filers: $182,100, with a full phase-out at $232,100.
• Married Filing Jointly: $364,200, with a full phase-out at $464,200.

When taxable income exceeds these levels, the deduction gradually decreases. For high-income businesses, deduction limits depend on W-2 wages and property basis.

Specified Service Trades or Businesses (SSTBs)

SSTBs are businesses based on individual reputation or skills, like law, health, and consulting. SSTBs face stricter limitations on deduction eligibility. If income exceeds thresholds, the deduction phases out quickly. SSTBs may lose the deduction entirely if they exceed the limits and lack wage or property requirements. Non-SSTBs may still qualify for higher incomes if they meet wage or property tests.

Using Trusts to Maximize the Deduction

Benefits of Trusts

Trusts can help maximize the Section 199A deduction by splitting income among beneficiaries. This strategy lowers taxable income, keeping it below the threshold for the full deduction. Distributing income through a trust reduces the grantor’s income, preserving the 20% deduction. Beneficiaries in lower tax brackets can receive income, paying less tax. Trusts can also allocate income to individuals or organizations with additional deductions, further reducing tax liability. Proper income distribution allows more QBI to remain within the deduction limits. Trusts can also aid in estate planning and wealth preservation. Income may be taxed at lower rates when distributed through the trust.

Caution on IRS Scrutiny

The IRS closely monitors trusts, especially those structured for tax avoidance. Improper use of a trust can lead to audits or penalties. Trusts must comply with IRS rules regarding income allocation among beneficiaries. The IRS could flag misallocating income or assigning it to low-income beneficiaries. Trusts should have legitimate purposes beyond tax reduction, such as estate planning. The income distribution must align with the trust’s terms and the beneficiaries’ needs. Failure to meet filing requirements can lead to penalties. Always consult a tax advisor or estate planner to ensure proper structuring. Properly structured trusts can reduce taxes while remaining compliant with IRS guidelines.

Common Pitfalls and Mistakes to Avoid

Misclassifying Income and Deductions

Misclassifying income and deductions is a common mistake that can disqualify you from the Section 199A deduction. Business income can be confused with investment income, such as dividends or capital gains, which don’t qualify. This mistake can reduce or eliminate your deduction. Additionally, personal expenses listed as business deductions may trigger IRS audits and penalties. It’s important to separate business and personal expenses to avoid errors carefully.

Not Considering State Tax Implications

Many states don’t follow federal Section 199A rules, affecting state-level tax deductions. Some states don’t allow the deduction at all. States like California don’t conform to federal tax law regarding the 199A deduction. Other states may apply limitations or exclusions to the deduction. Ignoring these state-specific rules could lead to unexpected state tax liabilities. Always research your state’s tax laws or consult a professional to ensure compliance.

Take Advantage of Year-End Tax Planning

Each strategy can help optimize your Section 199A deduction, but the ideal approach depends on your unique financial and tax situation. Our team is here to guide you through these options, ensuring you make informed, personalized decisions that maximize your year-end tax savings. Discuss how these strategies can support your tax planning efforts and enhance Section 199A benefits.

Let’s make this year-end one of smart planning and maximized tax savings.