As a physician and a business owner, you know how important it is to take advantage of key deductions that can reduce your tax liability. One beneficial—and often misunderstood—tax break for self-employed doctors is the qualified business income (QBI) deduction.
The QBI deduction is incredibly complex, but with a basic understanding of what it is and some careful tax planning, you can realize maximum benefit from it. So let’s dive in.
What is the QBI deduction?
The qualified business income (QBI) deduction, also known as Section 199A, is available to owners of eligible pass-through businesses, including sole proprietors, partnerships, LLCs, and S Corporations. It allows them to deduct up to 20% of their qualified business income from their taxable income. The deduction is claimed on the owner’s individual tax return—not the business return.
What is qualified business income?
QBI is the business’s net income, with a few exceptions. For example, QBI doesn’t include the following:
- Investment income, such as capital gains, dividends, or interest
- Income from businesses located outside of the U.S.
- Wage income
- Guaranteed payments from a partnership
You can find a complete list of what isn’t included in QBI in the IRS’s Facts About the Qualified Business Income Deduction.
Who qualifies for the QBI deduction?
For “specified service trades or businesses,” the QBI deduction may be limited or disappear entirely if the owner or shareholder’s total taxable income exceeds a certain amount.
A specified service trade or business (SSTB) is a service-based business that depends on its employees’ or owners’ reputation or skill. The IRS provides several examples of businesses that qualify as SSTBs in its QBI FAQs, but medical practices are on the list.
This means if your total taxable income, including wages earned by your spouse, interest, dividends, capital gains, rental income, etc., is above a certain amount, you might not be able to claim the QBI deduction or qualify for a reduced deduction.
For 2023, that cutoff is total taxable income greater than $182,100 for single filers and married couples filing separately and $364,200 for married couples filing a joint return.
Strategies to maximize the QBI deduction
There are additional rules, limitations and qualifications for claiming the QBI deduction but taking a detailed look at every facet of Section 199 is beyond the scope of this article. So instead, let’s look at some strategies for maximizing your write-off as a physician.
1. Utilize tax-advantaged retirement plans
Making use of retirement plans such as traditional IRAs, SEP-IRAs, SIMPLE IRAs, 401(k)s, and Solo 401(k)s can help reduce taxable income because you’re contributing pre-tax dollars to savings plans. This can help reduce your taxable income below the phase-out thresholds.
2. Take advantage of Section 179 and bonus depreciation
If you purchase furniture, equipment, or a vehicle for your business, consider writing off a larger percentage of the purchase price using Section 179 or bonus depreciation. These can reduce your taxable income, possibly putting you under the income limits to claim the QBI deduction.
3. Reconsider your S Corp election
Many businesses initially structured as LLCs elect to be taxed as S Corporations to reduce their self-employment taxes. However, this can have the unintended consequences of reducing their QBI deduction.
For example, say your business income is $300,000. Filing as an LLC, you could have a $60,000 QBI deduction. Assuming you’re in the 24% tax bracket, your savings would be roughly $14,400 ($60,000 x 24%).
Instead, you make the S Corp election and pay yourself reasonable compensation of $150,000, saving yourself $4,350 in Medicare taxes. By doing so, you cut your QBI deduction in half, adding $7,700 back to your tax bill.
The tax savings and consequences vary depending on your income and what constitutes reasonable compensation in your business. So if you’re considering an S Corp election (or wondering if a prior election was the right move in light of the QBI deduction), it’s a good idea to work with your tax advisor to run the numbers.
4. Spin off a non-SSTB portion of your business
Does part of your business earnings come from something other than your medical practice? If so, you may be able to maximize your QBI deduction with a spin-off.
For example, say you have a chiropractic office and generate 20% of your income selling nutritional supplements, orthopedic support pillows, exercise equipment, and other wellness supplies. If you can’t claim the QBI deduction because all your income comes from an SSTB over the income limits, you could establish an LLC or S Corporation for the supplement and wellness supply business alone. Since that aspect of the company isn’t an SSTB, the income from that entity could be eligible for the QBI deduction.
However, this strategy has some limitations. According to IRS guidelines, if a non-SSTB trade or business provides property or services to an SSTB and there is at least 50% common ownership, then that portion of the non-SSTB trade or business that provides property or services to the SSTB is treated as an SSTB.
5. Leverage capital loss harvesting
Capital loss harvesting is a tax strategy in which you sell losing investments to offset gains from other investments. Then, you can use that loss to “cancel out” gains you may have made in other investments, such as stocks or mutual funds.
For example, say you have $5,000 in capital gains and $3,000 in capital losses. You only have to pay taxes on the $2,000 difference. In addition, if your capital losses for the year exceed your capital gains, you can use up to $3,000 of those losses to offset other taxable income, including self-employment income.
This can reduce your taxable income and potentially increase your QBI deduction. However, it’s essential to consult with a financial or tax advisor before implementing this strategy. You want to ensure it fits with your overall investment strategy and you don’t run afoul of wash sale rules.
Many physicians cannot take advantage of the QBI deduction without a well-thought-out tax strategy due to its income limitations for owners of specialized service trades or businesses. If your income has you on the edge of losing out on this tax break and you would like to explore your options, tax planning can help. Check out our ROI page to see if you are a good fit for complementary tax analysis. The time invested may have a worthwhile return if it allows you to reduce your overall tax burden.