Clients who are in a professional services industry often consider themselves more sophisticated than the average taxpayer, but that doesn’t mean they aren’t overpaying in taxes! Read on to determine who is considered a professional services client, what core strategies they should all be using, and the powerful (but temporary) Qualified Business Income Deduction.
Who Counts as a Professional Service Client?
The first question is: who counts as a professional service client? Generally, someone who is in professional services is a client who provides their professional skills to someone else in exchange for compensation. They are often doctors, dentists, lawyers, accountants, or finance professionals, but they can also be artists or creative professionals like graphic designers. They are often highly educated, tend to be entrepreneurs and/or risk takers, and may be more sophisticated than other clients about things like money and taxes.
There are two main types of professionals we’ll focus on:
- Sole Proprietors – Individuals who are starting/own their company with very few or no other employees (other than possibly their spouse)
- Shareholders/Partners – Individuals who are in a partnership or S-Corporation structure with an ownership interest in the company.
These clients are all “selling” their professional skills to clients. While they have some differences, most of them will benefit from the strategies discussed here!
Tax Strategies Every Professional Service Business Owner Should Use
- Entity Formation/Optimization – Choosing the correct entity formation when you are first starting out is a good way to save time and money down the road as your company grows. Many businesses start off as a simple sole proprietorship just because it is easier to do so, only to spend thousands more later to form a different entity type. Analyzing the best structure at the beginning can save you money.
- Home Office Deduction – While many self-employed individuals know about the home office deduction, they are often timid in claiming it. Some may choose to only claim the safe harbor amount instead of determining their actual expenses. Self-employed individuals can deduct a portion of all their related home expenses from their business income when they work from home – including things like rent, mortgage interest, and internet costs. Just remember that the space used must be used “regularly and exclusively” for business purposes – your couch probably doesn’t count!
- Business Expenses – There are a lot of things you pay for on a regular basis for your business, so make sure you are claiming all of them as expenses! Shifting these expenses from your personal expenses to your business is a great way to maximize your deductions. Accountable plans are one way to do this: your business can reimburse you for business expenses, which are then deductible to the company and non-taxable for you! Fringe benefits are also a good strategy for business owners, as they are things you are probably already providing, but not writing off.
- Self-Employed Health Insurance Deduction: Did you know 25% of all self-employed workers do not have any health insurance coverage? Not only are these workers leaving themselves open to major medical financial issues, they are missing out on the ability to deduct the premiums! Self-employed workers can deduct 100% of all health insurance premiums for themselves, their spouses, their dependents, and any non-dependent children under the age of 26. This may also allow them to qualify for certain credits – tax savings snowball quickly!
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More Advanced Tax Strategies
The above strategies are easy for anyone to implement. Here are few more strategies that may take more time and effort to put in to effect, but are well worth it:
- Hiring Children – You can hire your children to work in your company, and provided it is a sole proprietorship, there are some great tax benefits. If your children are under the age of 18, their wages are only subject to income tax. If they are over 18 but still under 21, their wages are not subject to federal unemployment tax. This can (and should!) be stacked with a Child IRA to help set your child up for an early retirement
- Family Office Management Company – For families that want to hire their child but are formed as a partnership, S corporation, or C Corporation, you can create a separate company that qualifies to hire the children. The first company then hires the second company that employs the children to do certain tasks, such as bookkeeping or clerical work.
- Self-Employed Retirement Plans – Did you know that 20% of self-employed individuals are not saving for retirement at all? Only 68% report saving for retirement on a consistent basis, and those are mostly using IRAs. IRAs have small yearly contribution limits. Self-employed individuals should consider using a Solo 401(k), SIMPLE IRAs, or SEP IRAs to increase their contributions and potentially qualify for credits.
- Payroll Credits – if you have payroll, you may be missing out on credits! Credits are treated as if you have already paid a portion of your tax liability. Small business may qualify for credits such as the Small Business Health Insurance Premium Credit, the Work Opportunity Credit, the Credit for Paid Family and Medical Leave, and more!
The Qualified Business Income Deduction
The Tax Cuts and Jobs Act added section 199A to the tax code, which created a powerful deduction for taxpayers who earn pass-through income and meet the requirement. This deduction is referred to as the Qualified Business Income deduction, or “QBID.” Shockingly, nearly a million taxpayers who qualified for it didn’t claim it in 2019! This deduction is only temporary and expires in 2026, so business owners need to use it – before they lose it!
Anyone with pass-through income that is considered “qualified business income” is eligible for the QBID. The amount you can deduct is generally limited to 20% of your qualified business income. “Qualified Business Income” is defined as the “net amount of qualified items of income, deduction, gain, or loss with respect to any trade or business.” It does not include:
- Certain capital gains or losses,
- Interest income,
- Dividend income, or
- Income derived from a foreign source.
You must also adjust your qualified business income by subtracting out contributions to self-employed retirement plans, one-half of the self-employed tax, and self-employed health insurance premiums.
The QBI is a very complicated calculation, so your tax advisor should be consulted to determine the exact deduction. There are multiple calculations and limitations that must be considered. Generally, taxpayers are limited on the deduction they can take once their adjusted gross income exceeds 0,050 or 0,100 in 2022, depending on their filing status. These amounts are adjusted yearly for inflation.
Don’t Overpay in Taxes
If you’re a professional service professional, look into how much taxes you’ve paid this past year. Have you taken advantage of any tax strategies?
There’s a high chance you’ve overpaid. Corvee was created to help taxpayers save on their tax bills. With over 1,700 strategies, you’re bound to legally reduce your tax bill if you give it a try.