By: John S. Morlu II, CPA
The Qualified Business Income (QBI) deduction under Section 199A can provide significant tax savings for owners of flow-through entities such as S corporations and partnerships. However, the structure of the business and the taxpayer’s income level can greatly influence the size of the deduction. Strategic planning can help maximize the tax benefits.
Here’s a closer look at tax-saving tips for different scenarios and how the rules apply to flow-through entities.
Understanding the Thresholds
The 2024 taxable income thresholds determine how the QBI deduction is calculated:
| Filing Status | Threshold | Phase-Out Upper Limit |
| Married Filing Jointly | $383,900 | $483,900 |
| All Others | $191,950 | $241,950 |
- Below the Threshold: The QBI deduction is a straightforward 20% of QBI.
- Above the Threshold: The deduction is limited by W-2 wages and the Unadjusted Basis Immediately After Acquisition (UBIA) of qualified property.
Tip 1: S Corporations Have an Advantage Above the Threshold
If the business owner’s taxable income exceeds the phase-out threshold and the business is not a Specified Service Trade or Business (SSTB), an S corporation often has an advantage over a partnership.
Why?
- Guaranteed Payments vs. W-2 Wages:
- Partnerships often use guaranteed payments to compensate partners for services rendered. However, guaranteed payments are not considered wages for Section 199A purposes and do not increase the QBI deduction.
- S corporations, on the other hand, pay owner-employees through W-2 wages, which do count toward the wage calculation for the QBI deduction.
Example: Above the Threshold
| Scenario | Partnership | S Corporation |
| Total QBI | $200,000 | $200,000 |
| Guaranteed Payments or Wages | $100,000 (guaranteed payments) | $100,000 (W-2 wages) |
| W-2 Wage Component for QBI | $0 | $100,000 |
| QBI Deduction (limited by wages) | $0 | $20,000 (20% of QBI) |
Key Takeaway:
In this case, the S corporation provides a larger QBI deduction because W-2 wages are factored into the wage and capital limitation, whereas guaranteed payments are not.
Tip 2: Partnerships May Have an Edge Below the Threshold
When taxable income is below the phase-out threshold, partnerships may offer an advantage for the QBI deduction.
Why?
- No Wages Requirement for QBI Deduction:
Partnerships do not require payments to owners in the form of wages, whereas S corporations must pay reasonable compensation to shareholder-employees. - Impact on QBI:
For S corporations, wages reduce the amount of business income that qualifies as QBI. Partnerships avoid this reduction because they do not pay wages to partners.
Example: Below the Threshold
| Scenario | Partnership | S Corporation |
| Total Business Income | $200,000 | $200,000 |
| Wages to Owner | $0 | $80,000 |
| QBI | $200,000 | $120,000 |
| QBI Deduction (20% of QBI) | $40,000 | $24,000 |
Key Takeaway:
Below the threshold, partnerships typically offer a higher QBI deduction because there is no requirement to pay wages to owners, preserving more QBI.
Tip 3: Grouping Can Maximize Deductions Above the Threshold
For businesses with taxable income above the phase-out threshold, grouping multiple trades or businesses can increase W-2 wages and UBIA, leading to a higher QBI deduction.
What is Grouping?
Grouping allows taxpayers to combine related businesses for QBI purposes if the businesses meet certain criteria (e.g., shared ownership and interdependence). By grouping:
- W-2 wages across businesses are aggregated.
- UBIA of qualified property is also combined, increasing the potential deduction.
Example: Grouping Benefits Above the Threshold
| Scenario | Without Grouping | With Grouping |
| Business A (Wages) | $20,000 | $20,000 |
| Business B (Wages) | $10,000 | $10,000 |
| Total Wages | $20,000 (only A) | $30,000 (A + B) |
| UBIA of Property | $100,000 (only A) | $150,000 (A + B) |
| QBI Deduction (Wages Limit) | $10,000 (50% of $20,000) | $15,000 (50% of $30,000) |
Key Takeaway:
By grouping businesses, the taxpayer increases W-2 wages and UBIA, leading to a larger QBI deduction.
General Tax Planning Tips
1. Monitor Income Levels:
Taxable income thresholds are crucial. Falling below the phase-out threshold simplifies the QBI deduction calculation.
2. Choose the Right Entity Structure:
- Use S corporations for higher-income taxpayers to leverage W-2 wages.
- Use partnerships for lower-income taxpayers to maximize QBI.
3. Optimize Wages:
- For S corporations, ensure reasonable compensation is paid to shareholder-employees.
- Avoid overpaying wages, as this reduces the QBI base.
4. Consider Grouping Elections:
Grouping related businesses can increase eligible wages and UBIA for businesses above the threshold.
5. Work with a Tax Professional:
The rules around QBI deductions are complex, and personalized advice can ensure you’re optimizing your tax strategy.
Conclusion
The QBI deduction offers a significant tax-saving opportunity for flow-through entities, but maximizing it requires careful planning. Understanding how taxable income, entity structure, and grouping elections interact can help you make informed decisions tailored to your specific situation. Whether you’re operating as an S corporation or a partnership, strategic adjustments can lead to substantial tax savings.
Author: John S. Morlu II, CPA
John S. Morlu II, CPA, is the CEO and Chief Strategist of JS Morlu, a globally acclaimed public accounting and management consulting powerhouse. With his visionary leadership, JS Morlu has redefined industries, pioneering cutting-edge technologies across B2B, B2C, P2P, and B2G landscapes.
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