The qualified business income deduction introduced by the Tax Cuts and Jobs Act provides a significant new benefit for owners of flow-through entities and sole proprietorships. The qualified business income deduction is a boon for self-employed and small-business owners, allowing them to deduct up to 20% of their profits. It’s a substantial tax break but comes with complex rules and limitations. To maximize the benefit, taxpayers should consider consulting a professional. Generally, only pass-through entities are eligible for this deduction, which is also known as the Section 199A deduction.
The qualified business income deduction is available to sole proprietors, partners, S corporations, and LLCs with income from qualifying businesses. In contrast, C corporations are not eligible for the QBI deduction. Instead, these businesses pay taxes based on their profits and losses on separate tax returns from the individuals who own them.
How to Qualify for QBI Deduction?
To qualify for the QBI deduction, you must be involved in a “qualifying trade or business.” This includes most service-based businesses such as law firms, medical practices, accounting firms, and consulting businesses. However, the deduction may disappear once you reach a certain income threshold. Next, the business owner must have total taxable income under $170,050 for single filers or $340,100 for joint filers in 2024 to qualify for the deduction. This limit is adjusted for inflation each year. If you are over these limits, complicated IRS rules determine whether you can take the full or partial deduction. The rule also excludes certain types of income, including guaranteed payments, personal interest income, capital gains, and dividends. In addition, the rule phases out the deduction over $100,000 of taxable income if you are married filing jointly or $50,000 of taxable income if you are single.
How to Calculate QBI Deduction?
To calculate your QBI deduction, you must first determine your net qualified business income. This is your taxable income minus any negative items of income, gain, or loss. Next, you must determine the allocable portion of your W-2 wages and the unadjusted basis of your qualified property. This is calculated separately for each trade or business. Finally, you must subtract your QBI from your taxable income to arrive at your federal income tax deduction.
Taxpayers can calculate their QBI using the worksheet in the Form 1040 instructions or IRS Publication 535. Alternatively, they can use Form 8995-A for more complicated cases, such as those that involve SSTBs or multiple business owners. The calculation of this deduction involves aggregating the QBI from all qualifying businesses and applying two limitations: one based on W-2 wages and another based on the unadjusted basis in qualified property.
QBI Limitations
If a taxpayer’s income is above the thresholds for this deduction, they will have to limit their QBI by combining it with other income sources such as salary, wages, and investment income. Moreover, they may need to apply the W-2 wages and UBIA limitation in addition to the 20% qualified business income deduction.
The deduction is also subject to various limitations. The rules include a cap on the total deduction and a limitation on the amount of SSTB income that can be deducted. SSTBs are service-based businesses that depend on the reputation or skill of the owners or employees, such as law firms and doctor’s offices. Other examples include financial services companies, architects and engineers, and performing arts members.
If you own multiple pass-through entities, it is critical to keep up with the rules for this deduction. For example, the rules may be complex if you own a management company that manages several rental properties. However, if you are able to group the companies together, then you can combine the W-2 wages and qualified business income from all of the companies for purposes of this deduction.