Example 1: A pass-through business owner for whom preliminary household taxable income and pass-through income are both $415,000 (all taxable income comes from this pass-through source). By causing the business to adopt a retirement plan, especially a cash balance plan, if the business funded a retirement plan contribution of $100,000, preliminary household taxable income would now be $315,000, and 20% of pass-through income could be deducted. (This may not exceed 20% of the owner’s preliminary household taxable income reduced by capital gains). For a cash outlay of $100,000, taxable income would drop $163,000, which is calculated as the $100K cash balance contribution + (20% of $315K being passed through).
When the pass-through business income is in the $315K – $415K range (less if not married filing jointly) this principal applies on the income in the $315K – $415K range. When the presence of a new retirement plan deduction could get a higher business income figure down into this range this also applies.
Example 2: A business owner with $140K of pass-through business income and $124K of preliminary household taxable income could deduct only 20% of $124K. This person could increase taxable income by with a $20,000 in-plan Roth conversion, raising taxable income to $144,000. While this initially increases income $20K, the increased 20% deduction means that taxable income increases only $16K.
A person with pass-through business income but lower household taxable income can deduct only 20% of preliminary household taxable income. In this case the QBI deduction can be increased by increasing income. A common way to consider doing this is to make an in-plan Roth conversion, increasing taxable income, and thereby allow the full 20% QBI deduction. The in-plan Roth conversion would normally be fully taxable. This allows a 20% deduction on the conversion.
When an owner’s pass-through income is relatively low, as could easily happen for a person with a regular job but also some consulting or freelance on the side, helpful steps may include ensuring any deferrals are Roth, considering after-tax (rather than pre-tax) contributions, and considering an in-plan Roth conversion. Either of these would normally boost pass-through income and taxable income, pushing the QBI deduction upward.
