Santos Financial Secures $27,000 in QBI Deductions for Business Owner

Santos Financial Secures $27,000 in QBI Deductions for Business Owner

Executive Summary

A small business owner in California was unknowingly leaving significant money on the table by failing to claim the Qualified Business Income (QBI) deduction. Santos Financial Research Group identified this opportunity and implemented a comprehensive analysis of the client's business finances. By meticulously assessing income, expenses, and eligibility criteria, Santos Financial successfully secured a $27,000 QBI deduction for the client, significantly reducing their overall tax liability and freeing up capital for reinvestment in their business.

The Challenge

Dr. Ana Santos of Santos Financial Research Group was approached by a self-employed marketing consultant based in Los Angeles, CA. This consultant, we'll call him Mr. Davis, had been operating his business for five years, experiencing steady growth in revenue each year. While Mr. Davis was adept at running his core business, he admitted to feeling overwhelmed by the complexities of tax planning and relied primarily on generic online tax filing software.

In 2023, Mr. Davis's business generated a gross revenue of $320,000. His deductible business expenses, including office rent, marketing costs, and software subscriptions, totaled $85,000. This resulted in a tentative qualified business income of $235,000. He was concerned that this amount would push him into a higher tax bracket and significantly impact his overall profitability.

Prior to engaging Santos Financial, Mr. Davis was unaware of the QBI deduction and its potential benefits. He had heard vague mentions of it but lacked a clear understanding of eligibility requirements, calculation methods, and potential limitations. His previous tax preparers had also not highlighted this opportunity, resulting in missed tax savings in prior years. He was essentially paying an additional 10% to 12% in taxes that he didn't need to, which he later calculated came out to be around $20,000 to $24,000 on average. His biggest concern was unknowingly missing out on deductions and paying more in taxes than necessary, hindering his ability to invest further in his business's growth and secure his financial future.

The Approach

Dr. Santos began by conducting a thorough review of Mr. Davis's financial records, including income statements, expense reports, and prior-year tax returns. This initial assessment aimed to gain a comprehensive understanding of his business structure, income sources, and potential eligibility for various deductions and credits.

The core of the approach centered on meticulously applying the complex rules surrounding the QBI deduction. Dr. Santos considered several critical factors:

• QBI Calculation: Accurately calculating Mr. Davis's qualified business income by subtracting deductible expenses directly related to his business operations from his gross receipts. This involved carefully categorizing expenses to ensure they met the IRS's definition of qualified expenses.

• Taxable Income Threshold: Determining Mr. Davis's taxable income before the QBI deduction, which is a crucial factor in determining the allowable deduction. For 2023, the thresholds for single filers were a taxable income of up to $182,100 for the full deduction and a phase-out range up to $232,100. Dr. Santos calculated Mr. Davis's taxable income to be above the full deduction threshold, necessitating further analysis.

• Deduction Limitation: Applying the limitations based on taxable income and the type of business. Since Mr. Davis's taxable income exceeded the full deduction threshold, the QBI deduction was subject to limitations. The deduction is generally limited to the lesser of 20% of the QBI or 20% of the taxpayer's taxable income (excluding capital gains) or 20% of qualified REIT dividends and qualified publicly traded partnership (PTP) income. Furthermore, for taxpayers above the phase-out range, special rules apply based on whether the business is considered a Specified Service Trade or Business (SSTB). Marketing consulting is generally not an SSTB.

• Maximizing Deductions: Identifying and claiming all other eligible deductions and credits to further reduce Mr. Davis's taxable income, thereby potentially increasing the allowable QBI deduction. This involved exploring opportunities such as home office deductions, self-employment tax deductions, and retirement plan contributions.

Dr. Santos clearly communicated each step of the process to Mr. Davis, educating him on the rationale behind the calculations and empowering him with a better understanding of his tax situation. This transparency built trust and fostered a collaborative relationship.

Technical Implementation

The technical implementation involved utilizing Drake Tax software, a professional tax preparation tool widely used by accountants and tax professionals. The software was instrumental in calculating the QBI deduction based on Mr. Davis's specific business income and expenses.

Here's a breakdown of the key steps involved:

1. Data Entry: Accurately inputting all relevant financial data into Drake Tax, including gross receipts, deductible expenses, self-employment tax information, and other applicable deductions. This ensured the software had a complete and accurate picture of Mr. Davis's financial profile.
2. QBI Deduction Form Preparation: Using Drake Tax to generate Form 8995 or Form 8995-A (Qualified Business Income Deduction Simplified Computation or Qualified Business Income Deduction), depending on the complexity of the situation. The software automatically performed the complex calculations required to determine the allowable QBI deduction based on the applicable limitations and thresholds.
3. Taxable Income Calculation: The software calculated Mr. Davis's taxable income after considering all deductions and credits, including the QBI deduction. This provided a clear understanding of the impact of the QBI deduction on his overall tax liability.
4. Scenario Analysis: Dr. Santos utilized Drake Tax to perform "what-if" scenarios, exploring the potential impact of different income levels and expense amounts on the QBI deduction. This allowed for proactive tax planning and optimization strategies.
5. Documentation: The software generated detailed reports and supporting documentation to justify the QBI deduction, ensuring compliance with IRS regulations and providing a clear audit trail.

Specific calculations performed by Drake Tax included:

• Calculation of QBI: Gross receipts less deductible expenses directly related to the business.
• Application of Taxable Income Thresholds: Determining the phase-out range applicable to Mr. Davis based on his taxable income.
• Limitation Calculation: Calculating the lesser of 20% of QBI or 20% of taxable income (excluding capital gains).
• Self-Employment Tax Deduction Calculation: Factoring in the deductible portion of self-employment taxes to further reduce taxable income.
• Form 1040 Integration: Seamlessly integrating the QBI deduction into Mr. Davis's Form 1040, ensuring accurate tax reporting.

Results & ROI

By claiming the QBI deduction, Mr. Davis realized a significant reduction in his taxable income. Specifically, the QBI deduction amounted to $27,000. This meant that instead of being taxed on $235,000 of business income (before other deductions), he was now only taxed on $208,000.

The impact of this reduction was substantial:

• Tax Savings: The $27,000 reduction in taxable income translated to approximately $6,750 in federal income tax savings (assuming a 25% marginal tax rate).
• Effective Tax Rate Reduction: Mr. Davis's effective tax rate on his business income decreased from approximately 21% to 18.2%.
• Increased Cash Flow: The tax savings freed up $6,750 in cash flow, which Mr. Davis plans to reinvest in his business by upgrading his marketing software and expanding his online presence.
• Peace of Mind: Beyond the financial benefits, Mr. Davis gained peace of mind knowing that he was taking full advantage of all available tax deductions and minimizing his tax liability.
• Prior-Year Analysis: Following the 2023 success, Santos Financial also reviewed Mr. Davis's prior two years' tax returns and filed amended returns, securing an additional $11,000 in refunds collectively.

Key Takeaways

Here are some key takeaways for other RIAs and wealth managers:

1. Proactively Identify QBI Opportunities: Don't assume clients are aware of the QBI deduction. Make it a standard part of your tax planning process to identify potential eligibility.
2. Master the Complex Rules: Invest time in understanding the intricate rules and limitations surrounding the QBI deduction. This includes staying up-to-date on any legislative changes or IRS guidance.
3. Utilize Professional Tax Software: Leverage professional tax software like Drake Tax to accurately calculate the QBI deduction and generate supporting documentation.
4. Communicate Clearly with Clients: Explain the QBI deduction in a clear and concise manner, avoiding jargon and focusing on the tangible benefits for the client.
5. Review Prior Year Returns: Consider reviewing clients' prior-year tax returns to identify potential missed QBI deductions and file amended returns to claim refunds.

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