For many small business owners and high-income independent professionals, the new 2018 tax law is a mixed bag. While it does offer lower marginal tax rates at higher income levels, it also greatly reduces or eliminates popular tax deductions. For example, personal exemptions are repealed entirely and the much-used state and local tax (SALT) and property tax deductions have been limited to just $10,000 total.
Thus, the new tax law is less advantageous to those living in high-tax states such as California and New York.
Because many tax deductions have been reduced or eliminated, it is more important than ever for business owners to make the best use of the deductions for which they are still eligible.
Your Most Impactful Tax Strategy
In many cases, by far the most impactful tax-saving move a business owner can make is to establish and fund a defined benefit plan. Defined benefit plans are the gold standard of retirement plans, as they permit plan owners to contribute much more pre-tax money each year than either SEP-IRAs or 401(k)s, thus providing much higher annual tax savings. Some defined benefit plan owners are eligible to make tax-deductible contributions of more than $100,000 per year and thereby cut their tax bills by more than $35,000 annually.
For an overview of defined benefit plans, please click here.
Qualifying for the 20% Pass-Through Deduction
The new tax law offers self-employed individuals and small business owners a new 20% deduction on pass-through income. (Called the 199A deduction). One very useful aspect of defined benefit plan contributions is that they are “above the line” deductions that reduce taxable income. Thus, a business owner can make a large contribution to a defined benefit plan that can potentially drop him or her below the qualifying threshold for getting an additional 20% deduction on pass-through income. (The threshold is $315,000 for married tax-payers and $157,500 for individuals.) The tax savings can add up rapidly.
Consider the following example of a married independent consultant who earns $500,000 per year:
In this hypothetical case, the DB plan and 401(k) contributions, along with the 20% pass-through deduction, reduced this consultant’s tax bill by more than $85,000.
Using defined benefit plan and 401(k) contributions to reduce taxable income below the 20% pass-through thresholds should be investigated by all small business owners and independent professionals.
Even though it is only August, if you think a defined benefit plan might be able to work for you for 2018, it’s time to start investigating now. Plans are created for each person or firm individually, so drawing up the documents takes time. Pension actuaries also get very busy toward the end of the year as their backlogs build. In our view, it is prudent to get plans established by October 1, 2018 to get ahead of the year-end rush.
The most important date for potential defined benefit plan candidates to keep in mind is December 31, 2018. This is the deadline by which a defined benefit plan has to be established in order for it to be able to receive tax-deductible contributions for tax year 2018. The plan does not need to be funded, however, until the individual’s filing deadline, including extensions.
We specialize in constructing customized retirement plan solutions designed to maximize our clients’ tax savings while rapidly building their retirement wealth. You can fill out our online Tax Analysis Tool or you can email Peter Thoms directly and get the process started and see how much you can save. We only need a few pieces of information about your specific situation and we will generate a complimentary tax savings proposal for you within 48 hours.
You can also visit our dedicated defined benefit site, Defined Benefit Plan Solutions, to learn more.