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Can you take the new pass-through income deduction?

March 12, 2019

By Jennifer Garvin

Tax Reform

In 2017 the ADA successfully advocated to ensure the dental profession benefits from the Tax Cuts and Jobs Act — the first major rewrite of the U.S. tax code in more than 30 years. With the 2018 filing deadline approaching, the ADA News is featuring a series of articles focusing on how the new law will affect dentists beyond the revised standard deductions. The first article in the series ran Dec. 10, 2018, and discussed the Student Loan Interest Deduction. The second article ran Jan. 21 on IRS Code Section 179 depreciation expensing and a third article on cash basis accounting was published Feb. 18. This is the final article in the series.

The ADA News talked with Allen M. Schiff, a certified public accountant and president of the Academy of Dental CPAs, to see what dentists need to know if they want to take the pass through deduction. Mr. Schiff is the president of the academy, which is made up of 24 dental CPA firms representing more than 9,000 dental practices.

Tax Series Table

ADA News: What is the Qualified Business Income Deduction for pass-through businesses?

Mr. Schiff: The Qualified Business Income Deduction is a new concept that was introduced when the Tax Cuts and Jobs Act was passed into law on Dec. 21, 2017. The Tax Cuts and Jobs Act put in place several significant changes to the individual income tax law, one of which was the pass through deduction. This is only tax law until Dec. 31, 2025, whereby the current tax law will sunset.

What follows will sound very bizarre, but this is how it works. If your dental practice is operating as a pass-through entity, then potentially only 80 percent of the income is subject to tax.

ADA News: What qualifies as a pass-through entity?

Mr. Schiff: If your dental practice is taxed as a sole proprietorship (IRS Form #1040, Schedule C), or if it is taxed as a partnership (IRS Form #1065, Schedule K-1) or if your dental practice is taxed as an Subchapter S Corporation (IRS Form #1120S, Schedule K-1), then you potentially qualify for the 20 percent Qualified Business Income Deduction — known also as a QBI.

ADA News: What rules have to be met in order for dentists to take the deduction?

Mr. Schiff: For 2018, as long as your taxable income married or filing jointly is $315,000 or less (single $157,500 or less), you can potentially qualify for the full 20 percent QBI without a phase out of the 20 percent deduction.

The Internal Revenue Code’s definition of a specified service business includes many professional service businesses such as, accounting, legal, health care, actuarial science, performing arts, financial and brokerage services while excluding others like architecture and engineering. Within health care, dentistry is included. In addition to the above businesses, a specified service business is, “any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.” Thus, a dentist and/or the dental profession falls within this definition.

ADA News: If my income exceeds the threshold amounts will I still be able to take advantage of at least a partial deduction?

Mr. Schiff: Yes, even if your taxable income exceeds the $315,000 (married/filing jointly), as long as your taxable income is $415,000 or less, you can take advantage of the 20 percent QBI. Once your taxable income exceeds $415,000, you will no longer qualify for the 20 percent business income deduction. The taxable limitations for the single filing status are a low of $157,500 and fully phase out at taxable income of $207,500.

For example, let’s assume you are filing married/filing joint, and your taxable income is at $365,000. If this is the case, you would receive a 10 percent QBI as opposed to 20 percent. Why only 10 percent? Because the phase out begins at taxable income of $315,000 and fully phases out at $415,000. So, you can readily see, there is a $100,000 threshold here ($315,000-415,0000). So, if your taxable income is $365,000, which is the middle point of the threshold, the 20 percent is reduced by the 50 percent factor. Note: $365,000 is $50,000 greater than $315,000 or $50,000 divided by the $100,000 threshold equals 50 percent times the 20 percent QBI = 10 percent.

ADA News: How is the deduction for qualified business income computed?

Mr. Schiff: This is complicated but let’s use Chart A to explain.

ADA News: Can you provide us with an example of how a dental practice will take advantage of this deduction?

Mr. Schiff: For 2018, you still have time to plan, even tough we are amidst the 2018 Tax Filing Season. Here is an idea for you and your dental CPA to consider. Let’s assume you are filing, married/filing joint for 2018, and your taxable income share is approaching the $415,000 taxable limit. Let’s also assume, you could take accelerated depreciation (Section 179) in the amount of $100,000. By doing so, you could reduce your taxable income by $100,000, thus receiving the benefit of the QBI. (See Chart B for an example.)

Tax Series Table

Other Considerations from Mr. Schiff:
Once your taxable income exceeds $415,000, you will no longer qualify for the 20 percent business income deduction. If this is the case, you may want to take into consideration the accelerated depreciation deduction for equipment purchases and use the Section 179 Depreciation (as outlined in Chart B). By doing so, you could possibly bring your taxable income down from the upper limit of $415,000 and as a result, may qualify for the 20 percent income deduction. See ADA News 179 deduction article here.

If you have additional questions surrounding Qualified Business Income for 2018, please reach out to your CPA or if you are looking for a dental CPA, please visit www.adcpa.org.

The information in this piece is not intended to be, nor should it be construed as, tax, accounting or legal advice. Readers are urged to consult a qualified professional when seeking such advice. The ADA makes no endorsement of the above advice, nor of any website or organization mentioned in the above piece.