Qualified Business Income Deduction — What Consultants Need To Know


I had the pleasure of sitting down with Luke Frye, a Washington state CPA, and co-founder of Timber Tax, a web-based tax services company for freelancers and consultants, to talk about the Qualified Business Income Deduction (QBID). You can visit Luke's website at timbertax.co.

The Qualified Business Income Deduction is a new deduction on your taxes.

In this conversation, Luke and I discuss what the Qualified Business Income Deduction is and what it means for you, as a consultant and an independent business owner. 

Luke and I have spoken together on a number of occasions and I've always been impressed with his depth of knowledge.

Freelancers and consultants who are looking for tax services, check out Luke Frye at TimberTax.co

— Kai

Kai: Thanks so much for taking the time to join me today for the conversation, why don't you tell our audience a little bit about yourself and share your positioning statement?

Luke: Sure. My name is Luke Frye, I'm a Washington state CPA, and co-founder of Timber Tax, a web-based tax services company for freelancers and consultants, with a particular focus on photographers.

Kai: Excellent. Exciting. Well today we're going to talk about something new that just has come out, or is coming out, the Qualified Business Income Deduction, so start us off, tell us what exactly is the Qualified Business Income Deduction and why we should we as business owners care about it?

Luke: It's really a bit of a boon for anyone whose self employed. This is where we are saving money as a small business owner, with this new tax law. So I think so many things change, and I think one really important thing to know is that this is good for us. It doesn't necessarily simplify things, it actually complicates things, but it gets us a deduction regardless of how we're set up. If we're self employed, as long as we're not a c-corp. It's something that, as long as you have a specific type of income, under a certain threshold and several other items that we can certainly touch on, will enable us have an extra deduction, for our taxes.

Kai: Now that's wonderful, I think that sort of the dream of any independent business owner whose listening to this or wondering, 'What am I going to do when it come my taxes for this year?' So you mentioned that it's a boon for us, unless we're a c-corp, tell me a little more about the distinction between the different types of businesses that qualify for this and do no qualify for this.

Luke: Right. Generally speaking there are c-corporations and then everyone else. So c-corporations are ... I give a presentation where they're the evil corporations, they're the ones who can vote, they control elections, and so on and so forth. Regardless, they have that wall between the other, so a c-corp, you can't touch that money without it being taxed.

Kai: Mm-hmm (affirmative)

Luke: Whereas, essentially every other entity that we're gonna talk about, partnerships, s-corporations, both of those are very similar flow through, single member LLCs or sole proprietors, those are both reported on you individual 1040 schedule c. All of those last four, everything except the c-corp, will benefit, or may benefit, from this Qualified Business Income Deduction.

Kai: Diving into the may benefit bit, in a little bit of the research I did before this conversation, it seems like there are some exceptions for service providers, some service providers who are not allowed to take it. Tell me a little bit about sort of the landscape here.

Luke: Yeah, so this'll be interesting to see how it all unfold because, any time new law is made it goes into the internal revenue code, which is right behind me, right here. There are two books that are this big in the code, and then six that are treasury regulations. That's the baseline, okay?

Kai: Mm-hmm (affirmative)

Luke: And then on top of that are any court cases that come out of this, as well as what the IRS decides to treat things as. So even though something may be law, it may not be held up in court.

Kai: Mm-hmm (affirmative)

Luke: And so that will be a really interesting area to see, who is really qualified or not, and what that means in, architects and engineers get a special deal, they are treated more favorably overall, and then if you're using your services overall you will face some more hurdles to qualify for it, over certain thresholds, and we can talk about where those numbers are, but essentially over one fifty seven or three fifteen if you're single or joint filing. There goes a phase where it would phase out your deduction. So part of it would ... So what qualifies? Who qualifies? I think that will be a continuing area where there is already some guidance, there's some regulations out there, but who will have a little bit of a say in how that changes, we're still waiting to find out exactly. For the most part, if you're a professional service, that is where you will be excluded in certain ranges.

Kai: Okay. So if you're a professional service provider and you are not a c-corp, at certain income ranges, you said I think above three fifteen and one seventy five?

Luke: So if you're an individual, the limit would be one fifty seven, and it's essentially double that for a married filing joint. So that is where the interesting calculation comes in, if you like circular mind numbing calculations, that's where that comes in, above that threshold. Ultimately phases out completely, for some folks. And then there is an additional wage limit of W2s as well, depending on whether you are in that category.

Kai: Mm-hmm (affirmative) Okay so I sounds like this is absolutely a boon for the independent business owner, the service provider who is not a c-corp and it's potentially [inaudible 00:12:25] for the person who has a day job and is doing some amount of side hustling, freelancing, consulting on the side.

Luke: Yeah.

Kai: But the actual calculations of what that deduction is, can get a bit hairy and complex, as you dive into preparing your taxes.

Luke: Yeah. We're still waiting on a worksheet that really outlines it. If you're self employed, if you're consultant, a freelancer, you may be familiar with or even if you're not, on your tax return last year there was a self employment tax schedule that essentially walks through everything that does into it and then how it ends up being another tax that pay. We expect there to be another form similar to that, that will then flow through on your personal tax return. It depends. A lot of this unfortunately, it depends very much on your specific situation, but if you're a freelance or consultant who is making under one fifty, it remains tremendously more simple for you.

Kai: Mm-hmm (affirmative) And that's one fifty in terms of personal income, not necessarily business revenue?

Luke: So that would be the Qualified Business Income. Yeah.

Kai: Mm-hmm (affirmative)

Luke: Mm-hmm (affirmative)

Kai: Perfect. Please continue, I didn't mean to interrupt.

Luke: So I think one important distinction as an accountant, I try to avoid jargon as much as I can, but as the same time, important notes are revenue, right, is total gross receipts, total revenue. As opposed to net income, and then of course now we have this even more technical term that's very much focused on the taxes, that I'm sure we'll all become far more comfortable with, but the Qualified Business Income is specific for that business income on your tax return individually. And then that's with deductions.

Kai: Okay. I could see how it gets increasingly hairy as you dive deeper into actually preparing it for your taxes. It seems like there's a lot of [inaudible 00:14:22] involved here.

Luke: Yes, yes exactly.

Kai: And so you mentioned this is a deduction that is taken on the 1040, not necessarily the schedule c or elsewhere, am I correct in that?

Luke: Right, exactly. It looks like it will be on the top of page two, if you're very intimate with your tax return, at the bottom of page one is your AGI and that carries to the top of page two. That's your Adjusted Gross Income. THat's probably something you are familiar with. If you've ever had to re-log into the IRS or perhaps Turbo Tax, you may have had to have that number. More likely than not around the same neighborhood on page two on the top, as your itemized deductions would have gone, or would go, is probably where we're gonna see the Qualified Business Income Deduction.

Kai: Okay. That makes sense. What happens if I own multiple businesses? Does this deduction role up? How exactly does that play out?

Luke: Really good question, and I think again, it will very much depend on the specific service or business that you're operating, and this is an area of planning. So I think one term I might want to introduce to everyone is the idea of tax planning, and how much more important that going to be with this new tax law. That are many things that changed, many changes, and even before that, tax planning, if you're making over seventy five grand on your own, you can save yourself considerable cash. Around that, maybe it does make sense to create a separate entity. Is that a c-corp? Maybe.
Essentially what we would do for clients is look at how much revenue you're generating, what sort of entities you already have, and then say, 'Okay, what if we put this in a c-corp? What if we put this in an s-corp? What if we just left it alone?' We essentially weight the pros and cons and certainly tax savings is one of them. I think that's one of the biggest things that I get to chat with folks, there is a tax reason to do something, ultimately as much as I appreciate the tax law, and it provides for me, there are other reason to make decisions than just if you've saving taxes. Complexity is one, additional services, if you need to set up on payroll for example for an s corporation or a c corporation, additional tax filings additional costs. The costs are more than compliant and more than just tax savings.

Kai: That makes sense. Another question, what happens if I have a loss in my business for a year? How does that impact this deduction?

Luke: Interesting things about loss is you used to be able to carry them back, now you just carry them forward, and essentially you don't get a deduction if you don't have income, speaking about this very specifically Qualified Business Income Deduction, you don't get that, but it does flow forward, it has to eaten up, this loss has to be eaten up, before you would then calculate your income and then you would then calculate that deduction.

Kai: That makes sense. So if in 2017 the business experienced a loss, that's carried forward, applied to 2018 and then it's okay if there's Qualified Business Income left, then we start getting into the matter of calculating what the deduction looks like.

Luke: Yes. So I wouldn't look at it as, 'Oh I missed out on that deduction in the first year.' Or, 'My deduction is less.' Well, you know, theoretically yes the Qualified Business Income Deduction is less. Should be call it QBID? QBID? Is that what people are gonna call it?

Kai: QBID.

Luke: QBID.

Kai: I hope so.

Luke: That certainly will be less in that following year, but you total income will be counted as less because of that loss as well.

Kai: Mm-hmm (affirmative)

Luke: You're losing a smaller fraction to gain a bigger benefit.

Kai: That makes sense. We've touched on this a couple times, sort of as an aside, this is a relatively new law, this is a little but untested. Tell us a little bit about what that means in terms of application or what we might see in the next year or so.

Luke: A lot of changes. I think that there's gonna be a lot of things that catch people off guard. You know, quite often I get a lot of clients this time of year because they have self prepared and then they go in and they realize they may owe money and so, bit a sticker shock on their tax bill, and so they realize, 'Oh is there anything left that I can do this year to plan?' And the short answer is yes, but it depends. I think that's going to continue to happen with higher frequency in this. I think overall the benefit for Qualified, for QBID is more beneficial. But there are other things that went away. So a lot of the entertainment expenses, if you were going to Cirque de Sole a bunch I don't know if you're taking all of your clients to Cirque de Sole now or not, if you were-

Kai: [inaudible 00:19:44]

Luke: You're no longer able to deduct that. You can still do business meals, for bonafide purpose, but the entertainment went away. If you were really dependent upon that for your business, that could affect you substantially. I think that what we're gonna continue to see is more guidance. The IRS is going to have to issue a lot guidance around these issues, and then application too. For example, the healthcare mandate, and the penalty with that. There was a time when that was a silent, it was called filing a silent return, so you could not have insurance, file the return and not say whether you had insurance or not and you may have gotten away with it.
Well, there's still the penalty for this year, it comes down to a little bit of not only what is the law say, how is it enforced and how particularly close is the IRS paying attention to it? If you're a self employed person as I assume you are if you're listening or watching, I think making sure you budget time to talk through this once. If you've already filed you taxes for this year, June fifteenth is a a great time, to plan for to say, 'Okay is is about half of the year, where am I?' And talk to your tax professional.

Kai: One question I always get from listeners, from people who read my newsletter, is how should they go about finding a qualified tax professional in their area? What would you recommend to someday listening or watching?

Luke: It's sorta the same way you would get a dentist. I think there is an interesting parallel there because unfortunately, you don't really know how good of a dentist, how good of a job a dentist did until seven years later when that cavity may come back, or you need to have it refilled, or you wake up in the middle of the night. Similar to tax professionals. Obviously there are some easy ways check first. One would be, are they a CPA? Are they a licensed professional? Is their license in current good standing? That is public record, you can look at the state board of accountancy in any state and find that out. Enrolled agents are also competent tax prepares as well, and then a referral from someone whose good, but I think it again, only goes so far.
You mentioned, 'in their area' or 'in their state.' I think if you have many state taxes, or if you're dealing in something that has potential for sales tax, for example in Washington State or Colorado, how sales tax is collected on photos is completely different. It's fine to work with somebody out of state, if they have experience with it. For the most part if we're just talking state income taxes, and you just have one state, if you're a sole proprietor, I would say that you must find somebody in your state. It may be more preferential. From my point of view, I prefer to find somebody that I can establish rapport with, and have open and honest dialogue, and work together.
Those are the types of clients that I prefer, and hopefully the type of service that I am providing as well.

Kai: Beautifully stated. No I completely agree. I think you're absolutely right, it comes down to, that connection you're able to build with that service professional because it should a long term trusting relationship, not a, 'Oh we saw them one time and it didn't work out.' Ideally it's a lifetime.

Luke: Yeah. That's definitely our goal, is to make such that it is much more of a relationship ongoing. If you are the type of person to drop off a box of receipts at the end of year, or even just send financials at the end of the year, and sign something and turn a blind eye, you're really doing yourself a disservice and ... I tell clients, 'You're gonna pay me the same and you may as well, come meet me here, figuratively and let's go through this together and help you understand to make sure that you can make better decisions.' As opposed to just, 'I want this form. I want to sign this. When is my refund coming?'

Kai: Makes perfect sense. If people want to learn more about the services you provide, what's the best next step for them to take?

Luke: The easiest way is just to go to our website, TimberTax.co. And right there is my calendar, you can book a free call with me. And I am happy to chat through things, if you just have questions or you want to get going. And then try to make it as easy as possible.

Kai: Excellent. Anything else that listeners should know about QBID or any of the changes that have happened in the most recent tax update?

Luke: Yeah. I mentioned the entertainment one, for sure, so that went away if you were doing that a lot. The other thing that went away is the two percent itemized deductions. If you were doing those you probably know that, un-reimbursed business expenses, is a big one. If you also are an employee those went away. So two percent miscellaneous itemized deductions went away. The other really big one that changed is the SALTS deduction, State and Local Taxes. If you're in a state where you not only pay income tax heavily, California, New York, and you also own a home, so you're paying taxes on that. You're going to find you're itemized deduction tremendously limited to ten thousand dollars. And again it depends on where your assets are and whether this property is in a business of some sort, or if it's just you personal home, but overall states with a higher income tax, and if you own property and are paying taxes there, you're going to find a bigger high, a higher tax bill in your situation. Again, something worth planning around and the middle of the year is a great time to do that. Just do a check in with somebody to make sure that you have that dialed in.

Kai: That's perfect now, thank you so much for sharing those updates. Luke it's always a pleasure to speak with you and thank you so much for joining me to talk through QBID and help the listeners and people viewing this, understand exactly what it means for their business.

Luke: Absolutely. It'll be a fun thing to continue figuring out. So just make sure that, if you're working with somebody, keep asking questions.

Kai: Perfect. Well thank you so much and we'll talk again soon.

Luke: Thank you.

Freelancers and consultants who are looking for tax services, check out Luke Frye at TimberTax.co