With the passage of the tax cuts and jobs Act beginning in 2018 there’s a new deduction called the qualified business income deduction also known as qbi.
The deduction can be claimed by owners of pass-through entities subject to the limitations allowed. pass-through entities include sole proprietorships including independent contractors such as real tours, partnerships, LLCs, and S corporations. C corporations and their shareholders cannot claim the qualified business income deduction as a C Corp is not a qualified business. Additionally employees can take the deduction with respect to their wage income.
The deduction is not a business write-off on Schedule C or F and it is not a reduction from gross income to reduce adjusted gross income. The deduction is taken into account in figuring taxable income and which your applicable tax rates apply. it can be taken whether or not you itemize personal deductions.
The deduction is 20% of qualified business income. The full 20% deduction applies if your taxable income, not just business income, is more than $315,000 on a joint return or $157,500 on any other type of return. This taxable income threshold applies regardless of your type of business which means even if you’re in a specified service trade or business you get the full deduction.
Example: you are a realtor with qbi of $50,000 and taxable income of $95,000. Business income deduction is $10,000 20% of $50,000. In effect you are paying income tax on $40,000 of profit as a realtor even though the deduction does not directly reduce the amount of profit subject to tax.
If your taxable income exceeds the threshold for the type of return if you file then various limitations come into play.
Qualified Business Income
The 20% deduction is figured on qualified business income. QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts. Generally this includes, but is not limited to, the deductible part of self-employment tax, self-employed health insurance, and deductions for contributions to qualified retirement plans (e.g. SEP, SIMPLE and qualified plan deductions).
QBI does not include items such as:
QBI I also does not include amounts paid by an S corporation treated as reasonable compensation to the owner. So if an S corporation has income of $100,000 and pays out $40,000 as salary to the owner, only the $60,000 is treated as qbi.
Income Threshold
If your taxable income is over $315,000 on a joint return or $157,500 on any other type of return then limitations apply.
For those with taxable income over the thresholds noted above the deduction is limited to the lesser of one 20% of qualified business income or to the greater of 50% of W-2 wages.
Specified service trades or businesses
There’s another rule that effectively limits the QBI to 20% deduction for specified service trades or businesses. An sstb can be defined as any business where its principal asset is the reputation or skill of one or more of its owners or employees. Most commonly these include doctors lawyers accountants financial advisors actuaries athletes and Performing artists. Real estate agents and brokers are not considered SSTBs and therefore are fully eligible to claim the QBI deduction.
Individuals and some trusts and estates with QBI, qualified REIT dividends or qualified PTP income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives are required to reduce their deduction under section 199A(b)(7) (patron reduction).
S corporations and partnerships are generally not taxable and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI items, W-2 wages, UBIA of qualified property, qualified REIT dividends and qualified PTP income items on a Schedule K-1, or on a statement attached to, so the shareholders or partners may determine their deduction.
A4. QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends, and interest income are excluded. W-2 income, amounts received as reasonable compensation from an S corporation, amounts received as guaranteed payments from a partnership, and payments received by a partner for services under section 707(a) are also not QBI.
A qualified trade or business is any section 162 trade or business, with three exceptions:
A6. The SSTB limitation discussed in Q&A 5 does not apply if a taxpayer’s taxable income (before the QBI deduction) is at or below the threshold amount, discussed in Q&A 5; the deduction is the lesser of:
If the taxpayer’s taxable income (before the QBI deduction) is above the threshold amount, the deduction may be limited based on whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis immediately after acquisition of certain property used by the business. For 2018, these limitations are phased in for joint filers with taxable income above $315,000 but below $415,000, and all other taxpayers with taxable income above $157,500 but below $207,500. The threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years. Income earned through a C corporation or by providing services as an employee is not eligible for the deduction regardless of the taxpayer’s taxable income. In some cases, patrons of horticultural or agricultural cooperatives are required to reduce their deduction under section 199A(b)(7) (patron reduction). See also Q&A 13 for more information on computation and available worksheets.
A7. The SSTB limitation does not apply to any taxpayer whose taxable income (before the qualified business deduction) is at or below the threshold amounts discussed in Q&A #5. For taxpayers whose taxable income is within the phase-in range discussed in Q&A #6, the taxpayer’s share of QBI, W-2 wages and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB. The threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years.
In some cases, patrons of horticultural or agricultural cooperatives are required to reduce their deduction under section 199A(b)(7) (patron reduction). See also Q&A 13 for more information on computation and available worksheets.
A13. There is no form for reporting the QBI deduction in 2018. However, two worksheets have been developed to help taxpayers compute their deduction. The first worksheet is located in the instructions to Form 1040 and can be used by taxpayers with taxable income (before the QBI deduction) at or below the threshold amount ($315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers) and that are not patrons in a horticultural cooperative.
The second worksheet will be located in Publication 535, Business Expenses. It should be used by taxpayers with taxable income exceeding the threshold amount. It should also be used by taxpayer’s that are patrons of specified agricultural or horticultural cooperatives.
For tax year 2019, Form 8995, Qualified Business Income Deduction Simplified Computation, and Form 8995-A, Qualified Business Income Deduction, will be available and will replace the worksheets found in the Form 1040 instructions and Publication 535, respectively.
No. The QBI deduction does not reduce net earnings from self-employment, under section 1402. Similarly, the deduction does not reduce net investment income under section 1411 (Form 8960, Net Investment Income Tax).
If your taxable income (before the QBI deduction) is at or below the threshold, then most of the limitations are not applicable.
The specified service trade or business, W-2 wage, and UBIA limitations do not apply to taxpayers whose taxable income is at or below these thresholds.
The deduction is limited to the lesser of 20% of QBI plus 20% of qualified REIT dividends and qualified PTP income or 20% of taxable income less net capital gain for all taxpayers, regardless of income.