Tell Me about the Cliff
You have two opportunities to go off the cliff. The first opportunity applies to every passthrough business that pays no W-2 wages. Let’s say you are married filing a joint return, own no qualifying property, and pay no W-2 wages in your pass-through entity:
With taxable income of $315,000 and qualified business income of $315,000, your Section 199A tax deduction is $63,000.
With taxable income between $315,000 and $415,000 and qualified business income of $315,000, you are in the phase out range heading for the cliff at the upper end.
With taxable income of $415,000 and qualified business income of $315,000, your Section 199A tax deduction is ZERO. You arrived at the cliff.
For single taxpayers with no W-2 wages or property in their pass-through entities (proprietorships, S corporations, or partnership), the cliff is $207,500.
The second opportunity to go off the cliff applies to the out-of-favor service business which gets no deduction “regardless of wages or property” when it has taxable income of $415,000 (joint tax return) or $207,500 (single).
Avoiding the Cliff
If you are the business owner suffering from the cliff, what could you do to revive your tax deduction? First, you need to know that you have the problem. And you likely need to know about this problem as early in the year as possible, so you have maximum opportunities to reduce your taxable income.
If you are in an out-of-favor service business above the upper taxable income thresholds of $415,000 (married, filing a joint return) or $205,500, you need tax deductions. You might find new deductions after the end of the year and before you file your tax return by establishing a simplified employee pension, one of the very few deductions available after the end of the year.
Strategies to Consider
Strategy 1. None
Strategy 2. Self-Employed Taxpayer Becomes S Corporation
Strategy 3. Cut Your S Corporation Salary
Strategy 4. Spin Off a Tax-Favored Business
Strategy 5. Create or Enhance Your Retirement Plan
Once your defined taxable income is above the thresholds, you need to consider tax planning—now. Why now? Because some of the strategies require that you have time on your side.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX are generally unaware of even the basic tax strategies available to them and may find themselves overpaying in taxes.