The impact of SEP-IRA backdoor Roth conversion on QBI

[osy85]

I am thinking of contributing to a SEP-IRA and immediately convert it to Roth (SECURE act allows Roth contributions to SEP-IRA but it seems non-trivial to set this up with Vanguard, etc., hence the backdoor conversion). 

With the conversion to Roth, the SEP-IRA contributions will be taxable income, but I am wondering if the SEP-IRA contribution will still reduce my "net" self-employment income, which in turn would reduce the Qualified Business Income tax savings? 

[Mike9241]

there are two limitations for the QBI deduction. the QBI itself and taxable income. 

QBI must be reduced for contributions to qualified retirement plans to the extent attributable to the trade or business (reg 1.199A-3(b)(1)(vi)

the contribution reduces taxable income but the conversion increases taxable income with no offset to the self-employment income for QBI purposes.

it gets more complicated if you SE income is from a specified service trade or business. Reg 1.199A-5 because the phase out is computed differently. (it's actually referred to as a phase-in because there is a phase-in of the eligible QBI reduction)  

[osy85]

Thanks! Can you please clarify this part: "the contribution reduces taxable income but the conversion increases taxable income with no offset to the self-employment income for QBI purposes" 

Does this mean that doing SEP-IRA followed by a conversion will have a joint net effect of zero to the taxable income, but will reduce the QBI benefits? E.g., if I have $100 self-employment income and put $20 in SEP-IRA and convert it to Roth, then I would still have $100 in taxable income. But for the calculation of QBI, only $80 will be considered. This would mean that the process of SEP-IRA followed by Roth conversion is (at least initially) worse than not contributing to SEP-IRA at all and putting the after-tax portion of the income into a regular brokerage. Of course the Roth-converted SEP-IRA will grow tax-free and it might still be beneficial, but I wanted to get a full understanding of the math. 

[dmertz]

The SEP-IRA contribution of a sole proprietor does not reduce self-employment taxes.  However, any deduction for a self-employed retirement contribution does reduce the amount of QBI on which the QBI deduction is calculated.  As far as I know, it would be better if the SEP contribution could be made directly as a Roth contribution since it that case it would not reduce the QBI deduction the way a deductible traditional SEP contribution would.

I wonder, though, if it's correct that TurboTax does not reduce by the amount of the Roth SEP contribution the income on which the QBI deduction is calculated.  If the business made a Roth SEP contribution for a non-owner employee, the business would treat that as a business expense the same as a traditional SEP contribution that would reduce the net profit of the business, reducing the QBI, so why would in not make sense to reduce QBI by the amount of a Roth SEP contribution made for the sole proprietor.