Margo r. jeffries blog sec. 199a changes retirement planning z gas tecate


In this situation, if you operate your business and live in a state without income tax, you have little reason to use a tax-deferred retirement account. You may as well use the tax-sheltered income and the savings created by the $15,200 Sec. 199A deduction for retirement savings.

At the income level described here, the Sec. 199A deduction pushes the household taxable income down well into the new 12% tax bracket which means that roughly $17,000 of your qualified dividend income and long-term capital gain income will be subject to a 0% tax rate.

Now, yes, you are absolutely correct that contributing $5,500 to a traditional IRA or 401(k) gets that taxpayer another $5,500 of annual tax deduction. That deduction annually saves her or him perhaps another $660 of taxes in a situation like that described here. But maybe those savings aren’t that compelling.

Do note someone further reduces their taxable income with an IRA or 401(k) contribution and that that reduction also reduces their Sec. 199A deduction. (In the example given here, that reduction in the Sec. 199A deduction “costs” about $130 of lost Sec. 199A tax savings.)

And then look at the big picture where someone foregoes those annual tax savings by using a taxable account. Over 35 years, she or he accumulates roughly $500,000 in real dollar terms (if they earn five percent annually and contribute $5,500 each year). The taxpayer will have paid $18,000 to $19,000 in income taxes over those 35 years. Which is a lot. But she or he then draws down that money without paying income taxes.

• Taxable accounts provide some taxpayers with meaningful estate planning benefits. The ability to gift stocks to heirs without income tax consequences, for example. And the Sec. 1014 step-up in basis when a shareholder passes away (which means heirs such as a spouse avoid capital gains taxes).

Once you understand the tax accounting reviewed in the preceding paragraphs, another actionable insight may come into focus… For some self-employed taxpayers, especially those living in states with either no state income taxes or very low state income taxes, Roth-IRAs and Roth-401(k) options lose much or even all of their attraction.

But even so, a Roth-style account offers benefits: You escape income taxes on the investment income earned inside the account. You don’t have to take required minimum distributions (though your heirs will.) And neither you nor your heirs pay income taxes on the money drawn from the account.

Over the next few years, some business owners might easily move a few hundred thousand dollars from tax-deferred retirement accounts to Roth-style accounts without (in one sense) paying additional income taxes. Escape Sec. 199A Disqualification with Pension

Here’s why: A single taxpayer with a taxable income in excess of $207,500 or a married taxpayer with taxable income in excess of $415,000 loses the Sec. 199A deduction if she or he earns that income in a “specified service trade or business,” such as white-collar profession… or if he or she runs a business that doesn’t have employees with W-2 wages or depreciable assets.

This disqualification and limitation stuff gets complicated quick. (I discuss the rules on specified service business disqualification in more detail here: Sec. 199A Pass-thru Entity Deduction and the Principal Asset Disqualification. And I cover the W-2 wages and depreciable assets limitations in detail here: Sec. 199A Deduction Phase-out Calculations.)

But the basic rule goes like this: In order to not lose the Sec. 199A deduction due to W-2 wages or depreciable assets limitations or due to being a specified service business, you need to have taxable income of $157,500 or less if single and taxable income of $315,000 or less if married.

However, if you set up a pension plan with a large contribution that pushes your income below the threshold amount, you regain the ability to use the Sec. 199A deduction. For example, if you set up a one-person 401(k) plan and use that to make a $50,000 pension fund contribution, that contribution lowers your taxable income to $157,500.

If you’ve considered a defined benefit pension plan before but passed on the idea due to the cost, that extra $63,000 of deductions may provide the extra financial incentive you need in order to make the move. Final Comments about How Sec. 199A Changes Retirement Planning

First comment: Clearly, Sec. 199A changes retirement planning for some small business owners. Most business owners need to reexamine their retirement plans. You may choose to stay with your current approach. But the landscape has changed. Make sure your plans shouldn’t change in response.

Second comment: The Sec. 199A statute runs from 2018 through 2025. Then, per the current law, the deduction goes away. As a result, business owners may want to act quickly in order to get as many years of Sec. 199A benefits as they can. And then, unfortunately, that 2025 sunset means in 2026 things will change again and you may need to update your retirement plan once more. Additional Sec. 199A Information