There are lots of nuances to the proposed 199A deduction for qualified business income (QBI). This post is in no way exhaustive, but it will hopefully answer enough basic questions to give you a better idea about what to discuss with a tax professional regarding the possibilities of receiving this deduction. (You should do that sooner rather than later, by the way. Time is running out to implement any needed changes for the 2018 tax year. You could potentially be leaving tens, or even hundreds, of thousands of dollars in the government’s pocket rather than yours.)
What is qualified business income (QBI)?
QBI is the net amount of qualified items of income, gain, deduction, and loss with respect to each of your qualified trades or businesses. It includes items allowed in the determination of your taxable income for the tax year that are also connected with the conduct of a trade or business within the U.S. or Puerto Rico.
It does NOT include the following:
- Capital gains and loss, dividends, or interest
- Any amount paid by an S corporation to its shareholders that is treated as reasonable compensation
- Guaranteed payment by a partnership to a partner for services rendered with respect to the trade or business
- The trade or business of being an employee
Is my trade or business “qualified”?
Qualified business income, by definition, must come from a qualified business and pass through to an eligible person. It is legally defined as any trade or business other than a specified service trade or business or being an employee. QBI cannot be aggregated with another trade or business. The service trades or businesses that do not qualify generally involve the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or 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 or owners OR which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.
Does my income qualify as QBI (also known as pass-through income)?
The rationale behind pass-through income is to protect small business owners from double taxation: one tax bill for the company and one for the individual. Pass-through income is not taxed at the corporate level but is taxed at the personal level. This tax structure only applies to partnerships, sole-proprietorships, and S corporations. If you are the small business owner of a company with one of those tax structures, your income may qualify.
Am I eligible for the QBI deduction?
We can’t say for sure whether or not you’re eligible without a rather extensive session of you answering a series of very specific questions, but there are some general parameters that will give you a better idea.
- Eligible individuals are not in the trade or business of being an employee. In other words, if the boss is someone other than you or your partner, you’re not eligible.
- If your trade or business is one mentioned in the previous section, you will not be eligible.
- Eligible individuals receive their income from a pass-through entity (partnership, sole-proprietorship, or S corporation).
- You do not have to itemize to receive the deduction.
What does the QBI deduction do?
The deduction reduces your taxable income. It does not impact the calculation of self-employment tax.
How much is the QBI deduction for those who are eligible?
If your taxable income does not exceed the income threshold ($315,000 for joint filers and $157,500 for all other taxpayers), the deduction is generally whichever is less between 20% of QBI and 20% of taxable income. If taxable income exceeds the threshold amount, the deductible amount will be the lesser between 20% of your QBI with respect to the qualified trade or business and the W-2 wage limitation. The wage limitation phases in and is calculated based on the ratio of your table income in excess of the threshold amount.
What are the limitations on the QBI deduction?
Limitations apply once taxable income exceeds the threshold amount (see above). The W-2 wage limitation phases in with calculations that involve ratios, wages, qualified property, and corporate tax structure.
Motivation to act now
Like we said, it’s a complex deduction, but don’t let the complexity deter you. There’s no sense leaving money on the table, especially when it means that Uncle Sam gets to pocket it. Pine and Co. CPAs would be happy to talk you through the process of determining your eligibility. We have already begun to meet with some clients to make certain they are structured to maximize this deduction. In addition to many other considerations, one extremely impactful thing to do is to coordinate your W-2 wages with the QBI so you don’t get unreasonably and artificially capped with your deduction. When we met with one client last week and balanced these two variables, we increased their overall tax savings by more than $100,000.