How To Change Your Residency To Another State For Tax Purposes

If you live in an unfriendly tax state such as New York or California, it’s not uncommon for your retirement plans to include a move to a more tax friendly state once your working years are over.  Many southern states offer nicer weather, no income taxes, and lower property taxes.  According to data from the US Census Bureau, more residents left New York than any other state in the U.S.  Between July 2017 and July 2018, New York lost 180,360 residents and gained only 131,726, resulting in a net loss of 48,560 residents.  With 10,000 Baby Boomers turning 65 per day over the next few years, those numbers are expected to escalate as retirees continue to leave the state.

When we meet with clients to build their retirement projections, the one thing anchoring many people to their current state despite higher taxes is family.  It’s not uncommon for retirees to have children and grandchildren living close by so they greatly favor the “snow bird” routine.  They will often downsize their primary residence in New York and then purchase a condo or small house down in Florida so they can head south when the snow starts to fly.

The inevitable question that comes up during those meetings is “Since I have a house in Florida, how do I become a resident of Florida so I can pay less in taxes?”  It’s not as easy as most people think.  There are very strict rules that define where your state of domicile is for tax purposes.  It’s not uncommon for states to initiate tax audit of residents that leave their state to claim domicile in another state and they split time travelling back and forth between the two states. Be aware, the state on the losing end of that equation will often do whatever it can to recoup that lost tax revenue. It’s one of those guilty until proven innocent type scenarios so taxpayers fleeing to more tax favorable states need to be well aware of the rules.

Residency vs Domicile

First, you have to understand the difference between “residency” and “domicile”.  It may sound weird but you can actually be considered a “resident” of more than one state in a single tax year without an actual move taking place but for tax purposes each person only has one state of “domicile”.

Domicile is the most important.  Think of domicile as your roots.  If you owned 50 houses all around the world, for tax purposes, you have to identify via facts and circumstances which house is your home base.  Domicile is important because regardless of where you work or earn income around the world, your state of domicile always has the right to tax all of your income regardless of where it was earned.

While each state recognizes that a taxpayer only has one state of domicile, each state has its own definition of who they considered to be a “resident” for tax purposes.  If you are considered a resident of a particular state then that state has the right to tax you on any income that was earned in that state. But they are not allowed to tax income earned or received outside of their state like your state of domicile does. 

States Set Their Own Residency Rules

To make the process even more fun, each state has their own criteria that defines who they considered to be a resident of their state.  For example, in New York and New Jersey, they consider someone to be a resident if they maintain a home in that state for all or most of the year, and they spend at least half the year within the state (184 days).  Other states use a 200 day threshold.  If you happen to meet the residency requirement of more than one state in a single year, then two different states could consider you a resident and you would have to file a tax return for each state. 

Domicile Is The Most Important

Your state of domicile impacts more that just your taxes.  Your state of domicile dictates your asset protection rules, family law, estate laws, property tax breaks, etc.  From an income tax standpoint, it’s the most powerful classification because they have right to tax your income no matter where it was earned. For example, your domicile state is New York but you worked for a multinational company and you spent a few months working in Ireland, a few months in New Jersey, and most of the year renting a house and working in Florida.  You also have a rental property in Virginia and are co-owners of a business based out of Texas.   Even though you did not spend a single day physically in New York during the year, they still have the right to tax all of your income that you earned throughout the year. 

What Prevents Double Taxation?

So what prevents double taxation where they tax you in the state where the money is earned and then tax you again in your state of domicile?  Fortunately, most states provide you with a credit for taxes paid to other states.  For example, if my state of domicile is Colorado which has a 4% state income tax and I earned some wages in New York which has a 7% state income tax rate, when I file my state tax return in Colorado, I will not own any additional state taxes on those wages because Colorado provides me with a credit for the 7% tax that I already paid to New York.

It only hurts when you go the other way. Your state of domicile is New York and you earned wage in Colorado during the year.  New York will credit you with the 4% in state tax that you paid to Colorado but you will still owe another 3% to New York State since they have the right to tax all of your income as your state of domicile.

Count The Number Of Days

Most people think that if they own two houses, one in New York and one in Florida, as long as they keep a log showing that they lived in Florida for more than half the year that they are free to claim Florida, the more tax favorable state, as their state of domicile.  I have some bad news.  It’s not that easy.  The key in all of this is to take enough steps to prove that your new house is your home base. While the number of days that you spend living in the new house is a key factor, by itself, it’s usually not enough to win an audit.

That notebook or excel spreadsheet that you used to keep a paper trail of the number of days that you spent at each location, while it may be helpful, the state conducting the audit may just use the extra paper in your notebook to provide you with the long list of information that they are going to need to construct their own timeline. I’m not exaggerating when I say that they will request your credit card statement to see when and where you were spending money, freeway charges, cell phone records with GPS time and date stamps, dentist appointments, and other items that give them a clear picture of where you spent most of your time throughout the year.  If you supposedly live in Florida but your dentist, doctors, country club, and newspaper subscriptions are all in New York, it’s going to be very difficult to win that audit.  Remember the number of days that you spend in the state is just one factor.

Proving Your State of Domicile

There are a number of action items that you should take if it’s your intent to travel back and forth between two states during the year, and it’s your intent to claim domicile in the more favorable tax state. Here is the list of the action items that you should consider to prove domicile in your state of choice: 

• Register to vote and physically vote in that state

• Register your car and/or boat

• Establish gym memberships

• Newspapers and magazine subscriptions

• Update your estate document to comply with the domicile state laws

• Use local doctors and dentists

• File your taxes as a resident

• Have mail forwarded from your “old house” to your “new house”

• Part-time employment in that state

• Join country clubs, social clubs, etc.

• Host family gatherings in your state of domicile

• Change your car insurance

• Attend a house of worship in that state

• Where your pets are located

Dog Saves Owner $400,000 In Taxes

Probably the most famous court case in this area of the law was the Petition of Gregory Blatt.  New York was challenging Mr Blatt’s change of domicile from New York to Texas.  While he had taken numerous steps to prove domicile in Texas at the end of the day it was his dog that saved him. The State of New York Division of Tax Appeals in February 2017 ruled that “his change in domicile to Dallas was complete once his dog was moved there”.  Mans best friends saved him more than $400,000 in income tax that New York was after him for. 

Audit Risk

When we discuss this topic people frequently ask “what are my chances of getting audited?”  While some audits are completely random, from the conversations that we have had with accountants in this subject area, it would seem that the more you make, the higher the chances are of getting audited if you change your state of domicile.   I guess that makes sense.  If your Mr Blatt and you are paying New York State $100,000 per year in income taxes, they are probably going to miss that money when you leave enough to press you on the issue. But if all you have is a NYS pension, social security, and a few small distributions from an IRA, you might have been paying little to no income tax to New York State as it is, so the state has very little to gain by auditing you.

But one of the biggest “no no’s” is changing your state of domicile on January 1st.  Yes, it makes your taxes easier because you file your taxes in your old state of domicile for last year and then you get to start fresh with your new state of domicile in the current year without having to file two state tax returns in a single year.  However, it’s a beaming red audit flag.  Who actually moves on New Year’s Eve? Not many people, so don’t celebrate your move by inviting a state tax audit from your old state of domicile

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

The Accountant Put The Owner’s Kids On Payroll And Bomb Shelled The 401(k) Plan

Big Issue

The higher $15,000 standard deduction for single filers has produced an incentive in some cases for business owners to put their kids on the payroll in an effort to shift income out of the owner’s high tax bracket into the children’s lower tax bracket.  However, there was a non-Wojeski accountant who advised his clients not only to put their kids on the payroll but also to have their children put all of that W2 compensation in the company’s 401(k) plan as a Roth deferral.

At first look it would seem to be a dynamite tax strategy but this strategy blew up when the company got their year end discrimination testing back for the 401(k) plan and all of the executives, including the owner, were forced to distribute their pre-tax deferrals from the plan due to failed discrimination testing.  It created a huge unexpected tax liability for the owners and all of the executives, completely defeating the tax benefit of putting the kids on payroll.  Not good!!

Why This Happened

If your client sponsors a 401(k) plan and they are not a “safe harbor plan”, then each year the plan is subject to “discrimination testing”.  This discrimination testing is to ensure that the owners and “highly compensated employees” are not getting an unfair level of benefits in the 401(k) plan compared to the rest of the employees.  They look at what each employee contributes to the plan as a percent of their total compensation for the year.  For example, if you make $3,000 in employee deferrals and your W2 comp for the year is $60,000, your deferral percentage is 5%. 

They run this calculation for each employee and then they separate the employees into two groups: “Highly Compensated Employees” (HCE) and “Non-Highly Compensation Employees” (NHCE).  A highly compensated employee is any employee that in 2025: 

• is a 5% or more owner, or

• Makes $160,000 or more in compensation

They put the employees in their two groups and take an average of each group.  In most cases, the HCE’s average cannot be more than 2% higher than the NHCE average.  If it is, then the HCE’s get pre-tax money kicked back to them out of the 401(k) plan that they have to pay tax on. It really ticks off the HCE’s when this happens because it’s an unexpected tax bill. 

Little Known Attribution Rule

ATTRIBUTION RULE:  Even though a child of an owner may not be a 5%+ owner or make more than $160,000 in compensation, they are automatically considered an HCE because they are related to the owner of the business. So in the case that I referred above, the accountant had the client pay the child $14,000 and defer $14,000 into the 401(k) plan as a Roth deferral making their deferral percentage 100% of compensation.  That brought the average for the HCE way way up and caused the plan fail testing.

To make matters worse, when 401(k) refunds happen to the HCE’s they do not go back to the person that deferred the highest PERCENTAGE of pay, they go to the person that deferred the largest DOLLAR AMOUNT which was the owner and the other HCE’s that deferred over $18,000 in the plan each.

How To Avoid This Mistake

Before advising a client to put their children on payroll and having them defer that money into the 401(k) plan, ask them these questions: 

• Does your company sponsor a 401(k) plan?

• If yes, is your plan a “safe harbor 401(k) plan?

If the company sponsors a 401(k) plan AND it’s a safe harbor plan, you are in the clear with using this strategy because there is no discrimination testing for the employee deferrals.

If the company sponsors a 401(k) plan AND it’s NOT a safe harbor plan, STOP!! The client should either consult with the TPA (third party administrator) of their 401(k) plan to determine how their kids deferring into the plan will impact testing or put the kids on payroll but make sure they don’t contribute to the plan.

Side note, if the company sponsors a Simple IRA, you don’t have to worry about this issue because Simple IRA’s do not have discrimination testing. The children can defer into the retirement plan without causing any issues for the rest of the HCE’s.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

New York May Deviate From The New 529 Rules

When the new tax rules were implemented on January 1, 2018, a popular college savings vehicle that goes by the name of a “529 plan” received a boost.  Prior to the new tax rules, 529 plans could only be used to pay for college.  The new tax rules allow account owners to withdraw up to $10,000 per year per child for K – 12 public school, private school, religious school, or homeschooling expenses. These distributions would be considered “qualified” which means distributions are made tax free.

Initially we expected this new benefit to be a huge tax advantage for our clients that have children that attend private school.  They could fully fund a 529 plan up to $10,000 per year, capture a New York State tax deduction for the $10,000 contribution, and then turn around and distribute the $10,000 from the account to make the tuition payment for their kids.

New York Does Not Allow K – 12 Distributions

States are not required to adhere to the income tax rules set forth by the federal government. In other words, states may choose to adopt the new tax rules set forth by the federal government or they can choose to ignore them.  The new tax laws that went into effect in 2018 will impact states differently.  More specifically, tax payers in states that have both income taxes and high property taxes, like New York and California, may be adversely affected due to the new $10,000 cap (unchanged for 2025) on the ability to fully deduct those expenses on their federal tax return.

As of May 2025, New York does not recognize the K -12 distributions from 529 plans as “qualified”.   Currently more than 30 states have announced that they will adhere to the new federal tax rules allowing K-12 qualified distributions from 529 accounts.  On the opposite side of that coin, the following states do not recognize K-12 distributions as qualified:  California, Illinois, Michigan, Minnesota, Nebraska, New Jersey, New York, Orgeon, and Vermont.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Moving Expenses Are No Longer Deductible

If you were planning on moving this year to take a new position with a new company or even a new position within your current employer, the moving process just got a little more expensive. Not only is it expensive, but it can put you under an intense amount of stress as there will be lots of things that you need to have in place before packing up and moving. Even things like how you are going to transport your car over to your new home, can take up a lot of your time, and on top of that, you have to think about how much it's going to cost. Prior to the tax law changes that took effect January 1, 2018, companies would often offer new employees a "relocation package" or "moving expense reimbursements" to help subsidize the cost of making the move. From a tax standpoint, it was great benefit because those reimbursements were not taxable to the employee. Unfortunately that tax benefit has disappeared in 2018 as a result of tax reform.

Taxable To The Employee

Starting in 2018, moving expense reimbursements paid to employee will now represent taxable income. Due to the change in the tax treatment, employees may need to negotiate a higher expense reimbursement rate knowing that any amount paid to them from the company will represent taxable income.

For example, let’s say you plan to move from New York to California and you estimate that your moving expense will be around $5,000. In 2017, your new employer would have had to pay you $5,000 to fully reimburse you for the moving expense. In 2018, assuming you are in the 35% tax bracket, that same employer would need to provide you with $6,750 to fully reimburse you for your moving expenses because you are going to have to pay income tax on the reimbursement amount.

Increased Expense To The Employer

For companies that attract new talent from all over the United States, this will be an added expense for them in 2018. Many companies limit full moving expense reimbursement to executives. Coincidentally, employees at the executive level are usually that highest paid. Higher pay equals higher tax brackets. If you total up the company's moving expense reimbursements paid to key employees in 2017 and then add another 40% to that number to compensate your employees for the tax hit, it could be a good size number.

Eliminated From Miscellaneous Deductions

As an employee, if your employer did not reimburse you for your moving expenses and you had to move at least 50 miles to obtain that position, prior to 2018, you were allowed to deduct those expenses when you filed your taxes and you were not required to itemize to capture the deduction. However, this expense will no longer be deductible even for employees that are not reimbursed by their employer for the move starting in 2018.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Warning To All Employees: Review The Tax Withholding In Your Paycheck Otherwise A Big Tax Bill May Be Waiting For You

As a result of tax reform, the IRS released the new income tax withholding tables in January and your employer probably entered those new withholding amounts into the payroll system in February.  It was estimated that about 90% of taxpayers would see an increase in their take home pay once the new withholding tables were implemented. While lower tax rates and more money in your paycheck sounds like a good thing, it may come back to bite you when you file your taxes.

The Tax Withholding Guessing Game

Knowing the correct amount to withhold for federal and state income taxes from your paycheck is a bit of a guessing game. Withhold too little throughout the year and when you file your taxes you have a tax bill waiting for you equal to the amount of the shortfall. Withhold too much and you will receive a big tax refund but that also means you gave the government an interest free loan for the year.

There are two items that tell your employer how much to withhold for federal income tax from your paycheck:

• Income Tax Withholding Tables

• Form W-4

The IRS provides your employer with the Income Tax Withholding Tables. On the other hand, you as the employee, complete the Form W-4 which tells your employer how much to withhold for taxes based on the “number of allowances” that you claim on the form.

What Is A W-4 Form?

The W-4 form is one of the many forms that HR had you complete when you were first hired by the company. Here is what it looks like:

Section 3 of this form tells your employer which withholding table to use:

• Single

• Married

• Married, but withhold at higher Single Rate

Section 5 tells your employer how many "allowances" you are claiming. Allowance is just another word for "dependents". The more allowances your claim, the lower the tax withholding in your paycheck because it assumes that you will have less "taxable income" because in the past you received a deduction for each dependent. This is where the main problem lies. Due to the changes in the tax laws, the tax deduction for personal exemptions was eliminated. This may adversely affect some taxpayers the were claiming a high number of allowances on their W-4 form because even though the number of their dependents did not change, their taxable income may be higher in 2018 because the deduction for personal exemptions no longer exists.

Even though everyone should review their Form W-4 form this year, employees that claimed allowances on their W-4 form are at the highest risk of either under withholding or over withholding taxes from their paychecks in 2018 due to the changes in the tax laws.

How Much Should I Withhold From My Paycheck For Taxes?

So how do you go about calculating that right amount to withhold from your paycheck for taxes to avoid an unfortunate tax surprise when you file your taxes for 2018? There are two methods:

• Ask your accountant

• Use the online IRS Withholding Calculator

The easiest and most accurate method is to ask your personal accountant when you meet with them to complete your 2017 tax return. Bring them your most recent pay stub and a blank Form W-4. Based on the changes in the tax laws, they can assist you in the proper completion of your W-4 Form based on your estimated tax liability for the year.If you complete your own taxes, I would highly recommend visiting the updated IRS Withholding Calculator. The IRS calculator will ask you a series of questions, such as:

• How many dependents you plan to claim in 2018

• Are you over the age of 65

• The number of children that qualify for the dependent care credit

• The number of children that will qualify for the new child tax credit

• Estimated gross wages

• How much fed income tax has already been withheld year to date

• Payroll frequency

At the end of the process it will provide you with your personal results based on the data that you entered. It will provide you with guidance as to how to complete your Form W-4 including the number of allowances to claim and if applicable, the additional amount that you should instruct your employer to withhold from your paycheck for federal income taxes. Additional withholding requests are listed in Section 6 of the Form W-4.

Avoid Disaster

Having this conversation with your accountant and/or using the new IRS Withholding Calculator will help you to avoid a big tax disaster in 2018. Unfortunately, many employees may not learn about this until it's too late. Employees that are used to getting a tax refund may find out in the spring of next year that they owe thousands of dollars to the IRS because the combination of the new tax tables and the changes in the tax law that caused them to inadvertently under withhold federal income taxes throughout the year.

Action Item!!

Take action now. The longer you wait to run this calculation or to have this conversation with your accountant, the larger the adjustment may be to your paycheck. It's easier to make these adjustments now when you have nine months left in the year as opposed to waiting until November.I would strongly recommend that you share this article with your spouse, children in the work force, and co-workers to help them avoid this little known problem. The media will probably not catch wind of this issue until employees start filing their tax returns for 2018 and they find out that there is a tax bill waiting for them.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

No Deduction For Entertainment Expenses In 2019. Ouch!!

There is a little known change that was included in tax reform that will potentially have a big impact on business owners.  The new tax laws that went into effect on January 1, 2018 placed stricter limits on the ability to deduct expenses associated with entertainment and business meals.  Many of the entertainment expenses that businesses were able to deduct in 2017 will no longer we allowed in 2018 and beyond.  A big ouch for business owners that spend a lot of money entertaining clients and prospects. 

A Quick Breakdown Of The Changes

new tax rules for entertainment expenses

No Deduction in 2019

Prior to 2018, if the business spent money to take a client out to a baseball game, meet a client for 18 holes of golf,  or to host a client event,  the business would be able to take a deduction equal to 50% of the total cost associated with the entertainment expense.  Starting in 2018, you get ZERO.  There is no deduction for those expenses. 

The new law specifically states that there is no deduction for: 

• Any activity generally considered to be entertainment, amusement, or recreation

• Membership dues to any club organization for recreation or social purpose

• A facility, or portion thereof, used in connection with the above items

This will inevitably cause business owners to ask their accountant: “If I spend the same amount on entertainment expenses in 2018 as I did in 2017, how much are the new tax rules going to cost me tax wise?” 

Impact On Sales Professionals

If you are in sales and big part of your job is entertaining prospects in hopes of winning their business, if your company can no longer deduct those expenses, are you going to find out at some point this year that the company is going to dramatic limit the resources available to entertain clients?  If they end up limiting these resources, how are you supposed to hit your sales numbers and how does that change the landscape of how you solicit clients? 

Impact On The Entertainment Industry

This has to be bad news for golf courses, casinos, theaters, and sports arena.  As the business owner, if you were paying $15,000 per year for your membership to the local country club and you justified spending that amount because you knew that you could take a tax deduction for $7,500, now what?  Now that you can’t deduct any of it, you may decide to cancel your membership or seek out a cheaper alternative. 

Impact On Charitable Organizations

How do most charities raise money?  Events.   As you may have noticed in the chart, in 2017 tickets to a qualified charitable event were 100% deductible.  In 2018, it goes from 100% deductible to Zero!!  It’s bad enough that the regular entertainment expenses went from 50% to zero but going from 100% to zero hurts so much more.  Also charitable events usually have high price tags because they have to cover the cost of event and raise money for the charity.  In 2018, it will be interesting to see how charitable organizations get over this hurdle. It may have to disclose right on the registration form for the event that the ticket cost is $500 but $200 of that amount is the cost of the event (non-deductible) and $300 is the charitable contribution. 

Exceptions To The New Rules

There are some unique exceptions to the new rules.  Many business owners will not find any help within these exceptions but here they are: 

• Entertainment, amusement, and recreation expenses you treat as compensation to your employees in their wages (In other words, the cost ends up in your employee’s W2)

• Expenses for recreation, social, or similar activities, including facilities, primarily for employees, and it can’t be highly compensation employees (“HCE”). In 2018 an HCE employee is an employee that makes more than $120,000 or is a 5%+ owners of the company.

• Expenses for entertainment goods, services, and facilities that you sell to customers

What’s The Deal With Meals?

Prior to 2018, employers could deduct 50% of expenses for business-related meals while traveling.  Also meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee.

Starting in 2018, meal expenses incurred while traveling on business remain 50% deductible to the business. However, meals provided via an on-premises cafeteria or otherwise on the employers premise for the convenience of the employer will now be limited to a 50% deduction.

There is also a large debate going on between tax professional as to which meals or drinks may fall into the “entertainment” category and will lose their deduction entirely.

Impact On Business

This is just one of the many “small changes” that was made to the new tax laws that will have a big impact on many businesses.   It may very well change the way that businesses spend money to attract new clients.  This in turn will most likely lead to unintended negative consequences for organizations that operate in the entertainment, catering, and charitable sectors of the U.S. economy.

Disclosure: For education purposes only. Please seek tax advice from your tax professional

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

More Taxpayers Will Qualify For The Child Tax Credit

There is great news for parents in the middle to upper income tax brackets.  The new tax law dramatically increased the income phase-out threshold for claiming the child tax credit.  In 2017, parents were eligible for a $1,000 tax credit for each child under the age of 17 as long as their adjusted gross income (“AGI”) was below $75,000 for single filers and $110,000 for married couples filing a joint return.  If your AGI was above those amounts, the $1,000 credit was reduced by $50 for every $1,000 of income above those thresholds.    In other words, the child tax credit completely phased out for a single filer with an AGI greater than $95,000 and for a married couple with an AGI greater than $130,000. 

Note:  If you are not sure what the amount of your AGI is, it’s the bottom line on the first page of your tax return (Form 1040). 

New Phaseout Thresholds Beginning In 2018

Starting in 2018 and for years going forward, the new phaseout thresholds for the Child Tax Credit begin at the following AGI levels:

Single Filer: $200,000

Married Filing Joint: $400,000

If your AGI falls below these thresholds, you are eligible for the full Child Tax Credit.  For taxpayers with an AGI amount that exceeds these thresholds, the phaseout calculation is the same as 2017.  The credit is reduced by $50 for every $1,000 in income over the AGI threshold.

Wait......It Gets Better

Not only will more families now qualify for the child tax credit but the amount of the credit was doubled.  The new tax law increased the credit from $1,000 to $2,000 for each child under the age of 17.

In 2025, a married couple, with three children, with an AGI of $200,000, would have received nothing for the child tax credit.  Now, that same family will receive a $6,000 tax credit. That’s huge!! Remember,  “tax credits” are more valuable than “tax deductions”.  Tax credits reduce your tax liability dollar for dollar whereas tax deductions just reduce the amount of your income subject to taxation.

This information is for educational purposes only.  Please consult your accountant for personal tax advice.  

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Business Owners: Strategies To Reduce Your Taxable Income To Qualify For The New 20% Qualified Business Income Deduction

Many small business owners have a QBI 20% deduction available for their pass-through income, but you may need to position your business to take full advantage of this lucrative tax deduction. It’s important to be aware that the Qualified Business Income ("QBI") deduction has taxable income thresholds. Once the owner's personal taxable income exceeds specific dollar amounts, the 20% deduction will either phase out or trigger an alternative calculation that could lower the deduction.

The Taxable Income Thresholds

Regardless of whether you are considered a “services business” or “non-services business” under the new tax law, you will need to be aware of the following income thresholds:

Individual: $197,300

Married: $394,600

These threshold amounts are based on the “total taxable income” listed on the tax return of the business owner. Not “AGI” and not just the pass-through income from the business. Total taxable income. For example, if I make $100,000 in net profit from my business and my wife makes $400,000 in W-2 income, our total taxable income on our married filing joint tax return is going to be way over the $394,600 threshold. So do we completely lose the 20% deduction on the $100,000 in pass-through income from the business? Maybe not!!

The Safe Zone

For many business owners, to maximize the new 20% deduction, they will do everything that they can to keep their total taxable income below the thresholds. This is what I call the “safe zone”. If you keep your total taxable income below these thresholds, you will be allowed to take your total qualified business income, multiply it by 20%, and you’re done. Once you get above these thresholds, the 20% deduction will either begin to phase out or it will trigger the alternative 50% of W-2 income calculation which may reduce the deduction.  The phase out ranges are listed below:

Individuals: $197,300 to $247,300

Married: $394,600 to $494,600

As you get closer to the top of the range the deduction begins to completely phase out for “services businesses” and for “non-services business” the “lesser of 20% of QBI or 50% of wages paid to employees” is fully phased in.

What Reduces "Total Taxable Income"?

There are four main tools that business owners can use to reduce their total taxable income:

• Standard Deduction or Itemized Deductions

• Self-Employment Tax

• Retirement Plan Contributions

• Timing Expenses

Standard & Itemized Deductions

Since tax reform eliminated many of the popular tax deductions that business owners have traditionally used to reduce their taxable income, for the first time in 2018, a larger percentage of business owners elected to take the standard deduction instead of itemizing. You do not need to itemize to capture the 20% deduction for your qualified business income. This will allow business owners to take the higher standard deduction and still capture the 20% deduction on their pass-through income. Whether you take the standard deduction or continue to itemize, those deductions will reduce your taxable income for purposes of the QBI income thresholds.

Example: You are a business owner, you are married, and your only source of income is $400,000 from your single member LLC. At first look, it would seem that your total income is above the $383,900 threshold and you are subject to the phase out calculation. However, if you elect the standard deduction for a married couple filing joint, that will reduce your $400,000 in gross income by the $30,000 standard deduction which brings your total taxable income down to $370,000. Landing you below the threshold and making you eligible for the full 20% deduction on your qualified business income.

The point of this exercise is for business owners to understand that if your gross income is close to the beginning of the phase out threshold, somewhere within the phase out range, or even above the phase out range, there may be some relief in the form of the standard deduction or your itemized deductions.

Self-Employment Tax

Depending on how your business is incorporated, you may be able to deduct half of the self-employment tax that you pay on your pass-through income. Sole proprietors, LLCs, and partnership would be eligible for this deduction. Owners of S-corps receive W2 wages to satisfy the reasonable compensation requirement and receive pass-through income that is not subject to self-employment tax. So this deduction is not available for S-corps.

The self-employment tax deduction is an “above the line” deduction which means that you do not need to itemize to capture the deduction. The deduction is listed on the first page of your 1040 and it reduces your AGI.

Example: You are a partner at a law firm, not married, the entity is taxed as a partnership, and your gross income is $250,000. Like the previous example, it looks like your income is over the $197,300 threshold for a single tax filer. But you have yet to factor in your tax deductions. For simplicity, let’s assume you take the standard deduction:

Total Pass-Through Income: $250,000

Less Standard Deduction: ($15,000)

Less 50% Self-Employ Tax: ($15,000) $200,000 x 7.5% = $15,000

Total Taxable Income: $220,000

While your total taxable income did not get you below the $197,300 threshold, you are now only mid-way through the phase out range so you will capture a portion of the 20% deduction on your pass-through income.

Retirement Plans – "The Golden Goose"

Retirement plans will be the undisputed Golden Goose for purposes of reducing your taxable income for purposes of the qualified business income deduction. Take the example that we just went through with the attorney in the previous section. Now, let’s assume that same attorney maxes out their pre-tax employee deferrals in the company’s 401(k) plan. The limit in 2025 for employees under the age of 50 is $23,500.

Total Pass-Through Income: $250,000

Less Standard Deduction: ($15,000)

Less 50% Self-Employ Tax: ($15,000)

Pre-Tax 401(k) Contribution: ($23,500)

Total Taxable Income: $196,500

Jackpot!! That attorney has reduced their taxable income below the $197,300 QBI threshold and they will be eligible to take the full 20% deduction against their pass-through income.

Retirement plan contributions are being looked at in a new light starting since 2018. Not only are you reducing your tax liability by shelter your income from taxation but now, under the new rules, you are simultaneously increasing your QBI deduction amount.

When tax reform was in the making there were rumors that Congress may drastically reduce the contribution limits to retirement plans. Thankfully this did not happen. Long live the goose!!

Start Planning Now

Knowing that this Golden Goose exists, business owners will need to ask themselves the following questions:

• How much should I plan on contributing to my retirement accounts this year?

• Is the company sponsoring the right type of retirement plan?

• Should we be making changes to the plan design of our 401(k) plan?

• How much will the employer contribution amount to the employees increase if we try to max out the pre-tax contributions for the owners?

Business owners are going to need to engage investment firms and TPA firms that specialize in employer sponsored retirement plan. Up until now, sponsoring a Simple IRA, SEP IRA, or 401(K), as a way to defer some income from taxation has worked but tax reform will require a deeper dive into your retirement plan. The golden question:

“Is the type of retirement plan that I’m currently sponsoring through my company the right plan that will allow me to maximize my tax deductions under the new tax laws taking into account contribution limits, admin fees, and employer contributions to the employees.”

If you are not familiar with all of the different retirement plans that are available for small businesses, please read our article “Comparing Different Types Of Employer Sponsored Plans”.

DB / DC Combo Plans Take Center Stage

While DB/DC Combo plans have been around for a number of years, you will start to hear more about them going forward. A DB/DC Combo plan is a combination of a Defined Benefit Plan (Pension Plan) and a Defined Contribution Plan (401k Plan). While pension plans are usually only associated with state and government employers or large companies, small companies are eligible to sponsor pension plans as well. Why is this important? These plans will allow small business owners that have total taxable income well over the QBI thresholds to still qualify for the 20% deduction.

While defined contribution plans limit an owner’s aggregate pre-tax contribution to $70,000 per year in 2025 ($77,500 for owners age 50+), DB/DC Combo plans allow business owners to make annual pre-tax contributions ranging from $60,000 – $345,000 per year. Yes, per year!!

Example: A married business owner makes $600,000 per year and has less than 5 full time employees. Depending on their age, that business owner may be able to implement a DB/DC Combo plan prior to December 31, 2025, make a pre-tax contribution to the plan of $345,000, and reduce their total taxable income below the $383,900 QBI threshold.

Key items to make these plans work:

• You need to have the cash to make the larger contributions each year

• These DB/DC plan needs to stay in existence for at least 3 years

• This plan design usually works for smaller employers (less than 10 employees)

Shelter Your Spouse's W-2 Income

It's not uncommon for a business owner to have a spouse that earns W-2 wages from employment outside of the family business. Remember, the QBI thresholds are based on total taxable income on the joint tax return. If you think you are going to be close to the phase out threshold, you may want to encourage your spouse to start putting as much as they possibly can pre-tax into their employer's retirement plan. Unlike self-employment income, W-2 income is what it is. Whatever the number is on the W-2 form at the end of the year is what you have to report as income. By contrast, business owners can increase expenses in a given year, delay bonuses into the next tax year, and deploy other income/expense maneuvers to play with the amount of taxable income that they are showing for a given tax year.

Timing Expenses

One of the last tools that small business owners can use to reduce their taxable income is escalating expense. Now, it would be foolish for businesses to just start spending money for the sole purpose of reducing income. However, if you are a dental practice and you were planning on purchasing some new equipment in 2025 and purchasing a software system in 2026, depending on where your total taxable income falls, you may have a tax incentive to purchase both the equipment and the software system all in 2025. As you get toward the end of the tax year, it might be worth making that extra call to your accountant, before spending money on those big ticket items. The timing of those purchases could have big impact on your QBI deduction amount.

Disclosure: The information in this article is for educational purposes. For tax advice, please consult your tax advisor.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.