Understanding QBI Adjustments for Retirement Plan Contributions: Balancing Tax Savings with Retirement Planning for Business Owners

The Qualified Business Income (QBI) deduction is a valuable tax break for business owners that was introduced as part of the Tax Cuts and Jobs Act of 2017. It allows some business owners to deduct up to 20% of their qualified business income, potentially lowering their taxable income significantly.

Certain things, like retirement plan contributions, can significantly impact your available QBI deduction. Understanding how these two elements interact is important for your overall tax strategy and long-term financial planning. In this post, we'll specifically explain how retirement plan deductions adjust your QBI and explore ways to balance tax savings with retirement planning.

What is the QBI Deduction?

The QBI deduction allows certain business owners to deduct up to 20% of their qualified business income from their taxes. It's a personal deduction that reduces your overall taxable income, not your business income. 

This deduction is available to sole proprietors, partnerships, S corporations, and some trusts and estates. However, the calculation is complex and there are income limits. For 2024, the full deduction is available for married couples with taxable income below $383,900 and single filers below $191,500. NOTE: There are additional rules and limitations if your business is classified as a Specified Service Trade or Business (SSTB).

The main benefit of the QBI deduction is that it can significantly lower your personal tax bill. For example, if you have $100,000 in qualified business income, you could potentially deduct 20% ($20,000), reducing your taxable income to $80,000. This can result in substantial tax savings, allowing you to reinvest more money into your business or personal savings.

How Retirement Plan Contributions Affect QBI

Retirement plan contributions can ultimately reduce your QBI deduction. When you contribute to a retirement plan, it lowers your taxable business income. This, in turn, decreases your QBI, which is the base for calculating your 20% deduction.

This adjustment applies to several types of retirement plans:

• Traditional 401(k) plans
• SEP IRAs
• SIMPLE IRAs
• Defined benefit plans

For example, if you contribute $10,000 to your SEP IRA, your QBI would decrease by $10,000. This means your potential QBI deduction would be based on a lower amount.

It's important to note that while Roth 401(k) contributions don't reduce your taxable income, they also don't affect your QBI. This is because Roth contributions are made with after-tax dollars.

NOTE: The above does not apply to Traditional or Roth IRA contributions, which are done outside of the business and have their own limitations related to contributions and deductibility.

How to Calculate the QBI Adjustment

To calculate your QBI adjustment for retirement plan contributions, follow these steps:

1. Determine your total qualified business income
2. Calculate your retirement plan contributions for the year
3. Subtract your retirement plan contributions from your qualified business income
4. Calculate 20% of this new, lower QBI amount

Here's an example:

Let's say your qualified business income is $100,000 and you contribute $20,000 to your SEP IRA.

1. Start with QBI: $100,000
2. Retirement contribution: $20,000
3. Adjusted QBI: $100,000 - $20,000 = $80,000
4. QBI deduction: 20% of $80,000 = $16,000
   
   

In this case, your QBI deduction would be $16,000 instead of $20,000 (20% of the original $100,000). This shows how retirement contributions can reduce your QBI deduction.

Remember, while this lowers your QBI deduction, you're still getting a tax benefit (and funding a future goal) from the retirement contribution itself! The key is finding the right balance for your situation.

Strategies for Maximizing QBI and Retirement Savings

Balancing retirement contributions with QBI deductions requires careful planning. Here are some key things to consider:

1. Evaluate your tax bracket: Higher-income earners may benefit more from retirement contributions than worrying about maximizing the QBI deduction. 
2. Consider Roth options: Roth contributions are made with after-tax dollars and don't reduce QBI, but offer tax-free growth.
3. Timing matters: You might adjust the timing and type of your retirement contributions based on your expected business income for a particular year. 
4. Look at all retirement plan options: Some plans, like cash balance plans, can offer larger contribution limits and are often overlooked. Make sure you work with your tax and financial advisor to review all savings options. 

While the QBI deduction is valuable, don't overlook the long-term benefits of retirement savings. We often find that a mix of strategies - some focused on immediate tax savings, others on long-term growth - provides the best overall financial outcome for our clients. The key is to create a plan that aligns with your specific business situation and personal goals.

Remember, what works best depends on your unique financial situation.

How Burney Tax Advisors Can Help

At Burney Tax Advisors, we specialize in tax planning & preparation strategies to help business owners. Our team stays up-to-date with the latest tax laws and strategies to help you maximize your benefits.

Working with a tax professional offers several advantages:

1. Accurate calculations: We ensure your QBI and retirement contribution calculations are correct, avoiding costly errors.
2. Tailored strategies: We create personalized plans that balance your tax savings and retirement goals.
3. Time savings: We handle the complex tax work, freeing you to focus on your business.

What sets Burney apart is our integrated approach between financial planning and tax advising. Burney Tax Advisors works closely with investment advisors with Burney Wealth Management who specialize in financial/retirement planning. This collaboration offers a seamless experience for our clients and avoids  common communication issues many business owners face when trying to coordinate between separate CPA and wealth advisory firms.

With our integrated services, you don't have to be the go-between. Your tax planning and preparation are in concert with your wealth management strategy. This means more efficient planning, fewer meetings for you, and a cohesive financial strategy that addresses both your business and personal financial goals.

By choosing Burney, you get a team of experts working together to optimize your financial situation, saving you time and potentially uncovering opportunities you might otherwise miss.

Your Next Steps for Understanding the QBI Deduction

Understanding how retirement plan contributions affect your QBI deduction is key to optimizing your tax strategy as a business owner. 

While the interplay between these elements can be complex, it also offers opportunities to balance immediate tax savings with long-term financial security. 

To make the most of these opportunities and ensure you're making informed decisions, consider partnering with the integrated team at Burney Tax Advisors and Burney Wealth Management.

Your Next Steps: Complimentary Tax Consultation

What questions do you have? I would love to hear from you, answer your questions, and learn more about your unique situation.

Reach out to me by emailing Burney Tax at info@burneytaxadvisors.com. We can set up a call, on Zoom, or on the phone and discuss more about what it means to be a client of Burney Tax Advisors. 

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Looking forward to our conversation!