Daniel Kravitz spent hours culling through the Tax Cuts and Jobs Act to see if he could find ways to help small business owners take advantage of the cuts included and still maintain their workplace retirement plans. One way he discovered was for these businesses to offer cash balance plans alongside their 401(k) profit sharing plans.
Both 401(k) plans and cash balance plans are above the line tax deductions, meaning they reduce a small business owner’s adjusted gross income. Since tax reform impacts pass-through entities, or companies where the income is passed through to the business owner, it’s important for these folks to understand the deductions available to them, says Kravitz, president of Kravitz, Inc., an Ascensus company, and owner of Cash Balance Online, a firm that provides web-based back office solutions for third party administrators.
Some business owners can now deduct up to 20% of their qualified business income, although that 20% deduction is subject to limitations and phase-outs, he says.
So who qualifies for the 20% deduction? Business owners of pass-through entities in any type of profession who have incomes below a specified threshold: $157,500 for a single filer and $315,000 for a person who is married and filing jointly. Business owners of pass-through entities that are not specified services firms but do have income above the threshold also qualify for this deduction, but it is subject to limitations, he says.
Business owners of pass-through entities that are specified service businesses — such as lawyers, accountants and medical professionals — and have taxable income above $207,500 for a single filer and $415,000 for someone who is married filing jointly, are the ones who could benefit most from offering a cash balance plan.
So, what is a cash balance plan? It is a pension plan in which an employer deposits a set percentage of participants’ yearly income plus interest into their individual accounts. For employers, this means they can also set aside $100,000 or more in their own account, as long as they give an equivalent percentage back to their employees.
Cash balance plans are similar to 401(k) plans in that each individual has their own account. These plans are more expensive to administer than a traditional 401(k) plan – about double the cost, says Kravitz – but they can reduce a small business’s year-end tax bill.
Kravitz points out that some pass-through businesses that might not qualify for the 20% tax deduction because they make too much money could potentially reduce their adjusted gross income enough through the use of a cash balance plan to qualify for the deduction.
“For most small business owners as pass-through entities, profits are passed through to owners and taxed at individual rates rather than at corporate rates,” Kravitz says. The tax reform law reduced the individual rate from 39.6% to 37%.
For specified service business owners with income above the threshold, a wage and capital limit applies. This means that the 20% deduction phases out or is reduced when their taxable income exceeds that threshold of $315,000 for a married couple.
“When taxable income is in the phase-out range, the deduction decreases as income increases,” Kravitz says. “When taxable incomes exceed the phase-out limit, the deduction is eliminated.”
Advisers to pass-through companies will have to do a plan vs. no plan analysis to help some pass-through businesses decide whether saving in this type of plan enhances their ability to take the new tax deduction, Kravitz says.
“We found that for a lot of our clients — a lot of successful business owners that are profitable professional service companies — make well over the threshold amounts and don’t qualify for the deduction,” Kravitz says. So they will have to determine if the costs of offering such a plan are less than the benefits they would gain by being able to take the 20% deduction.
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