What is the qualified business income deduction?
The Tax Cuts and Jobs Act of 2017 introduced Section 199A, the Qualified Business Income (QBI) deduction that gives small business owners a 20% deduction on pass-through income. The QBI deduction can lower the effective tax rate for small businesses from 37% to 29.6% when applied to qualified business income. There are several limitations that govern who can take the QBI deduction so let’s take a look at who qualifies.
Who qualifies for the QBI Deduction?
In order to qualify for the QBI deduction, business owners must have the following:
A “Pass-Through” Business
A “pass-through” business is a business whose profits flow through to its owners and are taxed under the individual income tax (your personal tax return). The eligible entity types are:
- Sole proprietorships
- Limited liability companies (LLCs)
- S Corporations
- Certain trusts
C Corporations are not eligible for the QBI deduction. If you’re unsure which entity type is best for your business, see our Simple Guide to Choosing the Best Entity Structure.
“Qualified Business Income”
According the the IRS, qualified business income is “the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business.” QBI does not include the following types of income:
- Investment income (capital gains/losses, dividends and interest)
- Income earned outside the U.S.
- Wage income
- Reasonable compensation from an S Corp
- Guaranteed payments made to partners
- and many more
Your total taxable income (inclusive of all types of income) for tax year 2019, before the QBI deduction is applied, must not exceed $157,500 if you are a single filer or $315,000 if you are married filing jointly. If your income is greater than the applicable limit, all is not lost. You can still take all or a portion of the deduction depending on the type of business you have and your total income.
Taking QBI When Your Income Exceeds the Limit
- If your business is a specified service trade or business (SSTB), you can get a partial QBI deduction if your total income for tax year 2019 is between $157,500 and $207,500 for single filers or between $315,000 and $415,000 for joint filers. An SSTB is defined as a service-based business in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management and trading. Engineering and architecture-based businesses are not included.
- If your business is not an SSTB, and your total taxable income for tax year 2019 is above $207,500 for single filers or $415,000 for joint filers, you may may get a partial QBI deduction limited to:
- the lessor of 20% of QBI –or–
- the greater of 50% of W-2 wages paid to employees or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property
- Lastly you can take advantage of several effective tax planning strategies that maximize your QBI deduction.
The QBI deduction is fairly complex but can be great for business owners if planned for. What’s great about the deduction is you can take it whether or not you itemize your deductions. The IRS provides an FAQ to aid you in determining your deduction but it’s always best to contact a tax professional for assistance calculating your deduction.
If you have questions or would like help calculating your deduction, please email us at firstname.lastname@example.org or call us at (347) 201-2045.