Pass-Through Income of $200K - $500K

One of the biggest changes in the 2018 Tax Law is that pass-through businesses, such as S corporations and LLCs, now get a 20% deduction for income.  This deduction is available whether the standard deduction is taken or deductions are itemized.

There is a big constraint that applies to service businesses.  Engineers and architects do not have a limit on their income, but other businesses that are based on reputation/skill face a limit.  This limit applied to health, law, consulting, athletics and yes, financial services.  The limit:

• Single – taxable income threshold of $1K with phase-out of $2K
• Married filing jointly – taxable income threshold of $3K with phase-out of $4K

In effect, there is a large penalty that kicks in with income over the thresholds, since the 20% deduction disappears.

In practice, this means that small business owners would not want to have income just over the thresholds, as that extra little bit of income can cost them thousands of dollars in extra taxes.

Fortunately, small business owners can reduce their taxable income by large amounts by setting up retirement plans.  If you are an employee, you can contribute only $18.5K to a 401(k) in 2018, plus an additional $6K if you are age 50 or older.  However, if you are the business owner, you can contribute an extra $36.5K to the 401(k).  If you need to put even more aside, you can set up a defined benefit or cash balance plan and contribute an additional $150K+.  In total, you might be able to save $200K+/year in these retirement plans, which can help bring your taxable income below the threshold and help you receive the 20% deduction.  Susan describes how the process works below.