This may seem counter-intuitive, but it is possible that a year-end Roth conversion could increase your Qualified Business Income (QBI) deduction.
First, note that the Qualified Business Income (QBI) deduction is the lesser of:
- 20% of your Qualified Business Income or
- 20% of your taxable income (excluding capital gains)
Let’s walk through two examples to see how a Roth conversion can increase the QBI deduction.
Example 1: No Roth conversion
A married couple have $300,000 of Qualified Business Income. For simplicity, we’ll assume no interest, dividends or capital gains.
The tentative QBI deduction would be 20% of $300,000 or $60,000.
However, their taxable income may be $300,000 – a standard deduction of $31,500 or $268,500.
20% of $268,500 would be $53,700.
As mentioned above, the Qualified Business Income deduction would be limited to the lesser of these two amounts or $53,700.
Example 2: $31,500 Roth conversion
Now consider a Roth conversion of $31,500.
The taxable income would be $300,000 plus a Roth conversion of $31,500 minus an offsetting standard deduction of $31,500 for a total of $300,000. As intended, 20% of $300,000 is $60,000.
By intentionally increasing the taxable income with a Roth conversion, the taxpayer is afforded the full Qualified Business Income (QBI) deduction of $60,000.
Note that increasing the amount of the Roth conversion further would not be helpful for increasing the QBI deduction as it is limited to the lesser of 20% of your QBI or taxable income (excluding capital gains).