Editor's Note: This article is part of the Financial Advisor series "How I Solved It." Advisors describe a client with a problem and what they did to help.

Matt Nadeau, a seasoned wealth advisor, recently came to a startling realization: "Due to the new tax law complexities, business owners and advisors need to take a closer look at all elements of a business owner’s overall tax plan," he said.

As you may recall, at the end of 2017 Congress passed the Tax Cuts and Jobs Act. Among other provisions, the tax overhaul created Section 199A of the Internal Revenue Code, which allows owners of certain pass-through businesses (i.e., businesses that pay income taxes at the individual owners' rates, not the corporate rate) to receive a deduction of as much as 20% of the company's profits.

But Section 199A also lowers the value of any tax-deductible retirement-plan contributions by counting them against corporate profits. It therefore reduces the size of the Section 199A tax deduction for many small businesses.

"The deduction for retirement plan contributions is factored into the determination of qualified business income," said Nadeau, a chartered financial analyst and wealth advisor at Piershale Financial Group in Barrington, Ill.

For Nadeau, this complication came to the fore when a client came in to discuss tax returns for 2018. The client was planning on making $55,000 in total contributions—the maximum allowed in 2018—to a Simplified Employee Pension Individual Retirement Arrangement (SEP IRA), a retirement account designed for business owners to provide future benefits for themselves and any employees. "This client was self-employed with no employees and had been making contributions to a SEP IRA since 2014 as a way to reduce income taxes," Nadeau recalled.

But this time, the SEP IRA no longer seemed like the best strategy.

The client, he said, is currently in the 24% tax bracket. With the new tax code, "instead of saving 24 cents on the dollar in taxes, the client would only be getting [about] 19 cents on the dollar now," explained Nadeau, because the contributions would count against the qualified corporate profits per Section 199A.

What's more, when you withdraw money from a SEP IRA, it's 100% taxable. "You do not get a qualified business income deduction for those withdrawals, he said. In this case, the client would be taking distributions at the ordinary income tax rate of 24%. Worse still, said Nadeau, "if the tax laws expire [at this point, they're only locked in through 2025], the client could be pulling the money out at the 28% bracket."

Nadeau's conclusion was that this client was better off not making contributions to a SEP IRA. Instead, he recommended "a different approach."

First « 1 2 » Next