The Tax Cuts and Job Act of 2017 made significant tax changes for Dentists and Doctors and other healthcare professions that own practices. One of the most significant parts of this law is the 20% qualified business income tax deduction.
What is the 20% Qualified Business Income Tax Deduction?
This is a tax deduction that provides up to a 20% tax deduction of your business profits (Qualified Business Income or QBI).
That means if you are a Dentist filing as married joint with $250,000 of business profits (QBI) and taxable income of $300,000, you could receive up to $50,000 as a tax deduction. Assuming a tax bracket of $24%, that's $12,000 in actual tax savings.
Before you call your CPA, there are some limitations.
Do you Qualify for the QBI Deduction?
There are a couple qualifications to qualify and receive this deduction.
This post is focusing on practice owners that serve patients. As a result here are your qualifications.
You must have qualified business income because that is the income eligible for this deduction.
As a practice owner you are considered to be in a service-based business (Dentist, Physician, Veterinarian, Optometrist, Chiropractor), you are subject to income limits before being phased out altogether. In 2019 the total phase-out happens with taxable income of $421,400 (Married Filing Jointly), $210,700 (Single, & head of household) and $210,725 (Married filing Separately). More Detail below.
Qualified Business Income: What type of income counts?
If you’re a Dentist or Doctor that owns a practice or is paid as a contractor (Via Form 1099) then you will likely have qualified business income that will be eligible for this deduction.
In general, your qualifying business income is the total income from your business after accounting for business expenses.
Business Revenue – Business Expenses = Profit or Qualified Business Income
In order to qualify for the QBI deduction, you have to have income that comes from a “trade or business,” something you do for profit that is considered “regular and continuous.”
Qualifying types of businesses include
- Sole Proprietorship
C-corporations aren’t eligible for this tax deduction.
Now that you know if you have qualified business income, we need to look at the income limitations.
Are you a specified service business?
The law limits the 20% QBI tax deduction on specified service businesses (SSTB) with high taxable income.
Due to this limitation, being considered a SSTB business is not advantageous to you.
Unfortunately the law outlines whether you are a SSTB or not.
The Specified service businesses were specifically named in the law to include any trade or business involving the performance of services in the field of (among others):
You may think your business is different and it may be, but In general if you are performing services in the field of health and provide medical services to patients you are considered a specified service business.
Yes that includes medical services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, Chiropractors and psychologists.
Which is why in this post we are focusing on the QBI deduction for a service based business.
What are the income limitations for Specified Service Trade or Businesses (SSTB)?
Ok so we have established that your business is a SSTB, so now we have to look at the income limitations with being an SSTB.
In 2019, if your taxable income is in excess of $421,400 (Married Filing Jointly), $210,700 (Single, & head of household) or $210,725 (Married filing Separately) you are totally phased-out
Qualified Business Income Deduction for SSTB
Married Filing Jointly
|Taxable Income||QBI Deduction|
|<$321,400||Eligible for Full 20% QBI Deduction|
|>$321,400 and <$421,400||Reduced Deduction (1% for every $1,000 over $321,400. i.e $10,000 over, 10% of Deduction Lost|
|>$421,400||Fully Phased Out (No Deduction)|
Single and Head of Household
|Taxable Income||QBI Deduction|
|<$160,700||Eligible for Full 20% Deduction|
|>$160,700 and <$210,700||Reduced Deduction (2% for every $1,000 over $160,700. i.e $10,000 over, 20% of Deduction Lost|
|>$210,700||Fully Phased Out- No Deduction|
What is taxable income?
Taxable income is typically all of your income (salaries, investments, business profits) less all of your deductions (standard deduction/ itemized deductions, etc).
There is a QBI taxable income that is different from your traditional taxable income. QBI taxable income is all your income that would be included on your personal tax return less net capital gains or qualified dividends, minus some 1040 deductions (i.e. the standard deduction).
Taxable income is important for 2 reasons.
1. It determines what you can earn before you start being phased out as a SSTB.
2.Your QBI deduction is limited to the lesser of 20% of your taxable income or your Qualified business income. In other words if your taxable income is lower than your QBI then you would be limited to taking only 20% of your taxable income. See example 3 below.
Examples to see how this deduction works for a Dentist.
Dr. Dentist is a practice owner and has QBI taxable income of $250,000 of which $150,000 is business profits from your practice.
If the Dr. files as married filing jointly she would qualify for a $30,000 tax deduction. If she is filing as single, then she would not receive any deduction.
Could be a good reason to get married?
Let’s say Dr. Dentist (Married Filing Jointly) increases her taxable income to $355,400 of which $250,000 is qualified business income from her practice. Since Dr. Dentist is over the threshold of $321,400 and is considered a service business then the deduction would be reduced.
You lose 1% of the deduction for each $1,000 over $321,400. Once you are $100,000 over or at $421,400 of QBI taxable income, then your QBI deduction has been reduced 100% and you are totally phased out.
$355,400 Taxable Income
- $321,400 QBI Phase-Out (MFJ)
$34,000 or 34% Reduction
34% of the deduction is reduced, leaving 66% as the actual deduction.
Total Potential QBI Deduction = $250,000 * 20% = $50,000
34% Reduction Due to income limits = 34% * $50,000 = $17,000
$50,000 (20% Deduction) - $17,000 (Reduction) = $33,000 QBI Deduction
What if you are a 1099 Associate or Contractor?
This works the same way whether you are a practice owner or being paid as a 1099 contractor. A 1099 Contractor is essentially the same as having your own business.
When you are a 1099 contractor, you may not have much other income. Maybe you are starting out with your first position or maybe that is just how you are structured because you are working for multiple dentists.
The following rule tends to affect people with all of their business coming form their business. We see this most with 1099 contractors.
If your taxable income is less than your business profits then you are limited on the QBI deduction to the lesser of the two.
Dr. New Dentist just started started as an associate and is being paid as a 1099 contractor. Her net business income after expenses (including self employment taxes) is $140,200. She is single and is just starting out so she doesn’t have any other income. As a result she takes the the standard deduction of $12,200.
Her QBI Income is $140,200.
No other income.
Her Taxable Income is $140,200 = $12,200 = $128,000.
Since her taxable income is less than her QBI income, the QBI deduction is going to be limited to the lesser of the two.
$128,000 (taxable Income) < $140,200 (QBI Income)
So her QBI deduction would only be $25,640 ($128,000 * 20%) rather than $28,040 ($150,200 * 20%).
Tax Planning for the QBI Deduction
If you are over the income limits causing you to be phased out from getting this deduction, tax planning is more important than ever!
This is especially true if you are in sight of the limits. Meaning if you're a single Dentist with income over $500,000 then there may not be much you can do to get down to under the limits. If you are a single Dentist with taxable income of $215,000, then with some tax planning you may be eligible to get a partial QBI deduction.
If you were to review your financial situation and look at potential ways to lower your income via retirement plans, health savings accounts or increasing business expenses by prepaying software expenses, purchasing that new digital X-ray machine or building out a new operatory.
What if I am not a Service Based Business?
Again since most businesses in the health space where you are treating patients are considered service based business, we wanted to focus this post on those.
If you are not a SSTB then there are very different rules for high earners. If you are under the initial income limits, then the rules are the same.
We will go into more detail on high earner non-service businesses in a different post.
To summarize what we reviewed:
You need to have Qualified Business Income to be able to qualify for the deduction.
The above details is based on you being considered a specified service business. We did not go over a business that isn't a SSTB.
The amount of your taxable income will determine how much if any of the 20% QBI tax deduction you will receive.
Are you eligible to get this 20% tax deduction? Contact Us today and we can analyze your tax situation.