The QBI deduction is a powerful tool in reducing your tax liability, but calculating the deduction can be tricky. The QBI deduction can prove a helpful tax reduction for those owners who qualify for it. But because it remains a deduction and not a tax rate reduction.
So its effectiveness depends on an owner’s tax bracket. It represents a temporary measure in the tax law.
What’s the QBI Deduction?
The qualified business income deduction, or QBI deduction, is a personal deduction limited to owners of pass-through entities.
These are sole proprietorships, partnerships, limited liability companies, and corporations, which are entities in which owners report their share of business income on their personal returns.
The QBI deduction is up to 20% of QBI from a pass-through entity conducting a trade or business in the U.S. (It also includes up to 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income.)
However, as you’ll see, there are many limitations that may prevent you from taking a qualified business income deduction.
The QBI deduction is a personal write-off that you can claim whether you take the standard deduction or itemize personal deductions.
The QBI deduction does not reduce business income or have any impact on self-employment tax for owners who are treated as self-employed individuals.
Who Qualifies for the QBI Deduction?
The QBI deduction is only available to owners of pass-through businesses, but the limitations don’t end there.
If your business is a “specified service trade or business”, your QBI deduction may be limited or disappear entirely once your total taxable income reaches a certain limit.
A specified service trade or business (SSTB) is a service-based business (other than engineering or architecture) where the business depends on the reputation or skill of its employees or owners.
That’s a broad definition, but it includes law firms, medical practices, consulting firms, professional athletes, accountants, financial advisors, performers, investment managers, and more.
If you have a specified service trade or business
You can determine whether you get the full 20 percent deduction, a limited deduction, or no deduction at all based on your total taxable income.
Total taxable income refers to all the taxpayer’s income before the QBI deduction is applied. This may include wages from other jobs, wages earned by your spouse (if married and filing a joint return), interest and dividends, capital gains, rental income, and more.
For most taxpayers, this will be the adjusted gross income shown on Form 1040.
|Filing status||Total taxable income||Available deduction|
|Single||$157,500 – 207,500||Partial deduction for SSTBs|
|Single||> $207,500||No deduction for SSTBs|
|Married Filing Jointly||< $315,000||20% deduction|
|Married Filing Jointly||$315,000 – $415,000||Partial deduction for SSTBs|
|Married Filing Jointly||> $415,000||No deduction for SSTBs|
If you don’t have a specified service trade or business
If your business is not an SSTB, but you have taxable income greater than $207,500 for a single filer or $415,000 for a married couple filing jointly, your QBI deduction is limited to the greater of:
- 50 percent of your share of the W-2 wages paid out in the business, or
- 25 percent of your share of the W-2 wages paid out in the business, plus 2.5 percent of qualified property
Qualified property includes all tangible, depreciable property that hasn’t reached the end of its depreciable life. For most properties, the depreciable life is 10 years.
Also for real estate, the depreciable life may be up to 39 years.
For Both SSTBs and Non-SSTBs
If the business owner has dividends from a real estate investment trust or publicly traded partnership income, there is a second deduction worth up to 20 percent of that income, which gets added to the QBI deduction.
After calculating the two deductions, add them together. Then calculate your overall limitation by taking 20 percent of:
- Your taxable income for the year (before considering the QBI deduction), minus
- Net capital gains, including qualified dividend income taxed at capital gains rates
This overall limitation ensures that the 20 percent deduction isn’t taken against income that is already taxed at the lower capital gains tax rate.
How is the QBI Deduction Calculated?
Here’s a simple example:
Kelvin is a business owner who files taxes as a single taxpayer and who owns a single-owner LLC (taxed as a sole proprietor on Schedule C):
- Kelvin has a total qualified income from his business of $70,000.
- He also has wages from a part-time job of $20,000.
- His total taxable income is $90,000. This is under the limit so the $157,500 limit, so the entire $70,000 can be used in the QBI calculation.
- Multiply the $70,000 by 20% to get the QBI deduction amount of $14,000.
Kelvin can still take the allowable business expense deductions on his Schedule C, in addition to the QBI deduction.
1. What does “Pass-Through Entities” refer to?
Pass-Through Entities refer to S corporations, LLCs, sole proprietorships, and partnerships where the tax is imposed on the personal tax return of the owner and not on the business. In other words, the income “passes through” the business and falls on the individual.
2. How do I know if my business is a pass-through entity?
If you are not paying income tax for your business by filing a separate Corporate Tax Return (Form 1120) but you are declaring income from all sources including that business in your personal tax return (on Schedule C of Form 1040), your business is a pass-through entity.
3. Where does the name “199A” come from?
This deduction comes from Section 199A of the Tax Cuts and Jobs act, hence the name. It is also referred to as the 20% Qualified Business Income (QBI) of Pass-Through Entities since it applies to businesses where income is taxed on the personal tax return of the owner or the partner.
The QBI deduction provides a generous tax break for businesses that qualify to claim it. However, as the rules and definitions above make clear, determining who can claim the QBI deduction and calculating it is no easy task.
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