One of the most talked about provisions of the Tax Cuts and Jobs Act of 2017 is the Qualified Business Income Deduction, a new tax benefit allowing entrepreneurs, self-employed individuals and investors to deduct 20 % of their business income in calculating their income tax. This was a significant change to the taxation of flow-through business income, and we just saw the true effect as the first returns were filed in April 2019. If you own a flow through entity, this was likely a huge benefit to you, assuming you met several basic tests.
What is QBI and how does it work?
QBI (Qualified Business Income) is income earned from a sole proprietorship, S Corporation, or partnership. It does not include wages earned as an employee. The deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026, and is generally 20% of the reported income, subject to several limitations. Business income is defined under IRS Code Section 162, which broadly defines a trade or business as “a regular activity engaged in with a profit motive”.
Eligible businesses include Trusts or Estates, Individuals, Partnerships, S-corporations or Sole Proprietors. C-corporations and Employee Wages are not eligible.
What Type of Income Qualifies?
All of your business income qualifies. However, there are restrictions if your business meets the definition of a “specified service.” A Specified Service Trade or Business (SSTB) is any trade or business that involves the performance of services included in the fields of:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Brokerage services
- Trades or business involving investing and investment management
- Or any trade or business “where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”
How is it Calculated?
After you determine if you qualify, there are a few steps, rules, and thresholds that must be evaluated before you can finally determine your entitled deduction.
If your business IS NOT a “specified service” business (see listing above), and your taxable income is less than $315k (MFJ – Married Filing Joint), the deduction is simply 20% of the net income passed out and reported on your personal income tax return.
- If your taxable income is greater than $315k (MFJ), there is a second threshold to calculate involving W2 wages of the business and unadjusted basis of fixed assets. If the 20% calculation is less than 50% of the W2 wages, then you will get the deduction in full. If the 20% calculation is more than 50% of the W2 wages, you are entitled to a deduction totaling the greater of 1) 50% of W2 wages or 2) 25% of W2 wages plus 2.5% of the unadjusted basis of qualified fixed assets.
- The taxable income threshold for those with a filing status of Single is one-half of the taxable income threshold for those with a Joint (MFJ) filling status.
If your business IS a “specified service” business (see listing above), the calculation has different tests/thresholds.
- If your taxable income is less than $315k (MFJ), then you are entitled to the 20% deduction in full.
- If your taxable income is between $315k and $415k (MFJ), there is a phase-out of the 20% deduction.
- If your taxable income is above $415k (MFJ), the 20% deduction is not available.
- The taxable income threshold for those with a filing status of Single is one-half of the taxable income threshold for those with a Joint (MFJ) filling status.
The QBI deduction can get even more complicated. For example, rental real estate may qualify as a business for QBI if, as a landlord, you have more responsibility than just collecting payment each month. However, if the tenant of your rental real estate activity is your “specified service” business and your overall taxable income is greater than the allowed thresholds, the 20% deduction is not allowed on the rental activity income.
Navigating through the thresholds, definitions, and calculations for the QBI deduction can get confusing and be extensive. Add in owning several businesses, some with losses, some with income, and planning becomes crucial to determine the best way to proceed. We’d love to help you determine if you benefited from this new deduction on your 2018 income tax return, or how best to plan for 2019. To discuss the possibilities, call us today.