Got it. Seems that it reiterates the point of how complex these decisions become over time AND how each person needs to evaluate their own situation. I laugh every time a new law is supposed to simplify the tax process. Every new law seems to further solidify the need for experienced CPAs, especially for those that have any level of complexity beyond simple W-2 income.

Thanks for the help.

There is a tax savings to putting that next $10,000 into a 401(k) account. In the example situation I described in the Sec. 199A changes retirement planning, it’s maybe $500-$550 a year. (That’s the tax deduction savings created by putting the deduction on your return.) It doesn’t seem super attractive to me. But it’s $500 or $550 “attractive”…

Also, your math is probably correct for many investors. And before Sec. 199A it may have been correct for most investors or even all investors. It’s Sec. 199A that’s changing landscape for some taxpayers.

Thanks for the detailed reply. That makes more sense now (I was thinking along those lines but was struggling to put it together without the example).

I guess I am still slightly confused as to the downside of ALSO taking the retirement account deduction. If that same individual placed $10,000 in a 401k, AGI is now $65k. Sec 199A deduction of $13k gets them to $52k AGI and so now they have $25.4k of room in the 0% bucket AND have money in a guaranteed tax-deferred account to protect against a scenario where there income goes up in the future.

Say there income goes to $150k in 5 years, they would now have a larger taxable account that they are required to pay div/inc taxes on because they are above the 0% bracket now even with deductions.

To be clear: I am definitely biased as I have always been taught to get as much $ as possible into tax-free/deferred accounts, and my own math has always proved this, so I am clearly struggling with this point.

So here’s the way I’m thinking about it using a very simple example:

Say someone is married, self-employed, lives in a state with no income tax, and makes before their Sec. 199A deduction $75,000.

In this situation, taxpayer gets a $15,000 Sec. 199A deduction (20% of that $75,000). That pushes their taxable income down to $60,000.

At that income level, the person has roughly $17,400 of “space” left in the 12% tax bracket.

That means that the taxpayer can earn up to $17,400 of qualified dividends and long-term capital gains and not pay any income taxes.

So now look at two options… Say taxpayer has two choices. He can

(a) have $500,000 in Vanguard US stock market index fund inside an IRA. That money produces about $10,000 of qualified dividends and long-term capital gains. Taxpayer is not taxed on that income yet. But he will be when he draws the money.

(b) have $500,000 in Vanguard US stock market fund outside an IRA. That money again produces about $10,000 of qualified dividends and long-term capital gains. However because all of this money is within the 12% tax bracket tax payer gets taxed at 0% rate.

The tax-free option beats tax-deferred option. Neither option burdens the taxpayer with tax in year 1. And the Vanguard account balance at end of year is same either way. But when taxpayer draws that $10,000 from tax-deferred account, he will pay income taxes on it.

I think another way to say this same thing: In the sort of special case situation like that described above, no tax deferral occurs. It’s weird… the IRA *is* a tax deferred account… but as compared to the other account, IRA doesn’t actually defer taxes.

And this important wrinkle: This is a special case situation. Not all self-employed folks will have the tax accounting work this way. Someone needs to be in a state with no state income tax, be earning investment income that’s taxed at the 0% tax rate (because person is in the 10% or 12% tax brackets) and have a big enough Sec. 199A deduction to make this investment income tax free.

BTW, your point about the 401(k) being a safer place to store wealth is a really good one. Thank you for sharing that point. I would also generalize and say that there are lots of other subtle benefits to a taxable account and to a tax deferred account that someone would want to consider.

If I am wrong disregard the below but the retirement account points seems to be missing a few notes.

1. Investments grow tax-deffered in the retirement accounts while in a taxable account there is an annual tax drag on income and dividends (Are you saying the 199A deduction offsets this in a taxable account?). It seems as though the time horizon matters when you take this into account. Yes, you may lose the 199A deduction but the tax-deferred growth can add up over time. The shorter the horizon, the less of the benefit of tax-deferred investment growth. I.e. When younger, take the retirement deduction, but as you approach retirement, focus more on the 199A deduction…at least this what I see.

2. Money going into retirement accounts comes from your highest marginal bracket so you are always getting your deduction from your highest bracket when going in. When it comes out, depending on your spending needs, it could easily come out at a lower effective tax rate creative a tax arbitrage spread. Something to consider.

3. 401ks typically provide better asset protection in comparison to a taxable accounts. This is hopefully never a issue, but it certainly is a small positive.