Getting To Know The Qualified Business Income Deduction
Corporate tax rates were reduced from a maximum rate of 35 percent to a 21 percent flat rate under the Tax Cuts and Jobs Act (TCJA). So, in order to keep pace with the new corporate rate, the qualified business income deduction (QBID) was created to provide savings opportunities for flow-through entities and sole proprietors. This valuable deduction allows some business owners to take a 20 percent deduction of qualified business income (QBI) earned in a qualified trade or business, which would lower the maximum individual rate from 37 percent to 29.6 percent for a pass-through owner. However, as you can imagine, certain limitations apply.
Digging Into The Deduction
Unlike the across-the-board cuts given to C corps, the rules associated with the QBID are rather complex.
Generally speaking, your QBID will be 20 percent of QBI (income, gain, deduction and loss with respect to the qualified trade or business) from an S corp, LLC, partnership, sole proprietorship, trust or estate at the owner level. Compensation and guaranteed payments, on the other hand, aren’t considered QBI; instead, they would reduce your QBI received from flow-through entities.
Certain businesses will struggle to take advantage of the QBID. This includes non-service businesses that rely on the efforts of their owners, and companies with limited employee or capital investments. Businesses classified as specified service trades or businesses (SSTBs), including those in the areas of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services and investment management, will also struggle.
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If your business doesn’t employ a substantial number of people relative to its size or invest in a considerable amount of property, the W-2 wage limit and unadjusted basis of property will likely minimize the deduction. For example:
- If your taxable income is below $315,000, then no limitation applies and the deduction will generally be 20 percent of QBI, regardless of whether your business is a qualified trade or business, or an SSTB.
- However, if your taxable income is between $315,000 and $415,000, the allowable deduction is phased in. W-2 wages and qualified property amounts will help determine the deduction.
- If your business is an SSTB and your taxable income is more than $415,000, unfortunately, no deduction is allowed.
- If your business isn’t an SSTB and your taxable income is more than $415,000, the deduction will be determined based on QBI, W-2 wages and qualified property.
Under the IRS’s final guidance, some business owners and entities may be able to aggregate multiple businesses to calculate the deduction as long as certain conditions are met. This would allow you to treat the aggregated businesses as a single activity when applying W-2 wages and qualified property limitations. Just remember that the total deduction amount cannot exceed your taxable income (minus the net capital gain/qualified dividends) for the tax year.
While the QBID might sound like a great way to reduce your tax liability, make sure you have the proper assistance before moving forward. It’s best to discuss this strategy with your advisor, who will help you determine your eligibility and offer strategies to optimize the availability of the pass-through deduction. Email me to learn more.
By Melissa Dunkle, CPA (Dublin Office)