The 2018 Tax Reform Bill made sweeping changes to the tax rules, and changed traditional thinking when it comes to entity selection.
Before 2018, many dentists were advised to entities taxed as S-Corporations. The tax savings for Medicare and Social Security taxes were the driving force behind that recommendation.
But for many dentists, Congress changed that when they passed the Tax Cuts and Jobs Act (TCJA). This major tax legislation will affect most dentists and change the way you do tax planning.
The TCJA added Code Section 199A which is a new tax deduction called the “Qualified Business Income Deduction”. If you operate your business as a sole proprietorship, partnership, or S corporation, your 2018 income from these businesses might qualify for the new 20 percent deduction.
The new 20 percent 2018 tax deduction can also apply to income you receive from your real estate investments, publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives.
IRC Section 199A Deduction Overview
To qualify for the new 20 percent deduction, with no exceptions, you need qualified business income from one of the sources above, and you need “Defined Taxable Income” of:
- $315,000 or less if married filing a joint return, or
- $157,500 or less if filing as a single taxpayer
“Defined Taxable Income” is taxable income, before considering any Section 199A deduction.
Example. You are single and operate your dental practice as a proprietorship. It produces $180,000 of qualified business income. With your other income and deductions, your defined taxable income is $150,000. You qualify for a deduction of $30,000 (the lesser of $150,000 or $180,000 x 20 percent).
If you operate your practice as a partnership or S corporation and you have the same qualified business income and defined taxable income numbers above, you qualify for the same $30,000 deduction. The same is true if your income comes from a rental property, real estate investment trust, or limited partnership.
Some VERY unfriendly rules apply to what Section 199A calls a “specified service trade or business”, such as operating a dental practice, where defined taxable income is above the thresholds above, plus phaseouts ($50,000 single or $100,000 married). At those income levels, the Qualified Business Income drops to ZERO for income from those sources.
But if you qualify, this new deduction now makes a big difference on your ultimate tax paid, depending on the entity you choose for your practice. Here is a sample calculation of the difference between being the S-Corporation favored before 2018, and a sole proprietor. For this example, a sole proprietor and an LLC taxed as a sole proprietor would be the same:
Example of Entity Comparisons for 2018
- Dentist earns $300,000 after overhead
- Assume “Reasonable Compensation” for Dentist is $180,000 for S-corp purposes
- Dentist is married, and has no other family income
- Assume state tax is 5%
- Assume the doctor does not itemize deductions on the 1040
|If Practice is
Taxed as a
|If Practice is
Taxed as an
|Schedule C Income||$300,000||
|Social Security Tax||-$24,622||
|Federal Income Tax||-$37,464||
|State Income Tax||-$15,000||
|Net After-tax Income||$222,914||
|Decrease in Net Income||
So all dentists need to review their choice of entity to be sure they have maximized their tax savings for 2018 and beyond.
Robert J. Gray, EA
Robert is a member of Gray Pilgrim and Associates, LLC, and is very proud to be one of the founding members of the Academy of Dental CPA’s, a distinguished group of accountants who specialize in the dental profession. Go to www.ADCPA.org to find one near you.