What is the Qualified Business Income (“QBI”) Deduction? – How does it work and who can take advantage of it?
October 9, 2018
With the tax cuts in full effect, the biggest, and certainly the most complicated, addition to the tax law is the 20% Qualified Business Income (“QBI”) deduction. This deduction was created in response to the tax cut given to C-Corporations. To even the playing field for all entity types, privately owned businesses were given the QBI deduction. This article gives a general overview of the QBI deduction and how it could apply to you and your business.
Pass-Through Entity Deduction
The QBI deduction has several factors on which the amount of the deduction is reliant. First, this deduction is limited to only pass-through entities; this means that C-Corporations do NOT get this deduction. Only those companies who organize as a sole proprietorship (Schedule C), a partnership (Form 1065), and an S-Corporation (Form 1120S) may take advantage of this deduction. However, simply having your company organized as one of these entities for tax purposes does not necessarily mean you will be eligible for the deduction.
In addition to the limitation on the form of business, the QBI deduction is also dependent upon the nature of your business. The law states that wages earned as an employee are not applicable and it splits business into two general categories – specified service trade or business (“SSTB”) and non-SSTBs. According to IRC Section 1202(e)(3)(A), “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees” is disallowed for this deduction (with one exception). The disallowed industries include health (doctors), law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Engineering and architecture are explicitly excluded from the list of disallowed industries and new guidance has been issued which also excludes real estate professionals.
Taxable Income Limitation
Another consideration with regard to the QBI deduction is the taxable income of the owner/partner of the business. The QBI deduction is taken on the personal tax return, NOT on the business tax return, and it is dependent upon the taxpayer’s taxable income. The taxable income limitation for this deduction is $157,500 for single filers and $315,000 for joint filers. If your taxable income is below this threshold, generally a 20% deduction of the qualified flow-through business income may be taken on a per-entity basis. After the threshold is reached however, the deduction begins to phase out. If any taxpayer’s taxable income is below these threshold amounts, the entire deduction is available. The phase-out threshold ends at $207,500 for individual filers and $415,000 for joint filers. At this point, the deduction is no longer available for specified service trades or businesses and is limited for non-personal service companies.
For non-personal service companies, the QBI deduction is limited to the greater of either 50% of the W-2 wages paid to employees in the firm, or 25% of the W-2 wages paid to employees plus 2.5% of the unadjusted basis of the qualified property in the business if the taxable income threshold is surpassed. This limitation could prevent high income sole proprietorships with no employees from taking the QBI deduction, but still benefit S-Corporations in which the owner must pay herself wages.
Question About the QBI Deduction?
Although the QBI deduction may seem fairly straightforward, there are many nuances that may make it difficult to interpret. If you have any questions or would like further information regarding the QBI deduction and how it could benefit you and your business, please contact one of Hoffman Clark’s consultants.