A quick rundown of what constitutes a qualified business income deduction.
You must have heard the oft-repeated phrase, “Nothing is said to be certain except death and taxes.” Well, we can’t argue otherwise, can we?
Do you know that you could certainly be entitled to a tax break based merely on the type of business you run? And, that the current tax policy regime could work in your favour too? I guess not.
Look no further, then. Here’s a quick rundown that’ll aid your understanding of what a qualified business income is and what it means for potential business owners.
Table of Contents
- 1 What is meant by Qualified Business Income?
- 2 What is a Qualified Business Income (QBI) Deduction?
- 3 What is meant by W-2 wages in Qualified business income deduction?
- 4 What is meant by “UBIA of Qualified property” in Qualified Business Income Deduction?
- 5 Does QBI deduction apply to owners having multiple businesses?
- 6 Conclusion
What is meant by Qualified Business Income?
Qualified business income is the share of profits you accrue from your own business. According to the IRS, it is essentially the net amount of income, gains and losses from qualified businesses, which include sole proprietorships, LLC’s (limited liability companies) and S corporations.
There are various elements that must not be accounted for when arriving at QBI. Items adjusted for are those that form part of the taxable income.The following are excluded;
- Investment items such as capital gains/losses and dividends.
- Guaranteed payments to and from organisations operating in a capacity other than that of a partner.
- Interest income arising from outstanding receivables.
- Income that is not directly allocable to the conduct of business within the United States.
- Business carryovers discontinued before 2018.
What is a Qualified Business Income (QBI) Deduction?
Qualified business income deductions (QBI deductions) can afford substantial savings to businesses that qualify for it- for tax years beginning after december 31st 2017.
Also called Section 199A, it allows eligible taxpayers to deduct up to 20 % of their qualified business income in addition to 20% of qualified real estate investment interest (RIET) dividends and publicly traded partnership income.
What businesses qualify for the QBI Deduction?
Businesses operating through pass-through entities or direct taxpayers come under the eligibility of the deduction. The following are listed below:
- S corporations
- Sole proprietorship
- Limited Liability Companies (LLC)
The QBI deduction is subject to certain limitations related to the type of business in question, the amount of taxable income and W-2 wages paid by the qualified businesses.
The QBI deduction is not only available to owners of pass-through entities.
Certain exceptions qualify a business to claim the deduction. If they hold, the QBI deduction may be very limited based on the taxable income.
One of them includes an exception for a specified service trade or business (SSTB) conducting services in the fields of consulting, financial services, actuarial science, trading, law, or carrying out trade/business where the principal asset is the goodwill of the company or the skillsets of its employees. The exception, in this case, will only be applicable if the joint return filed by a married couple exceeds $321,400.
Moreover, for a married taxpayer filing separately, the taxable income should exceed $160,725 while $160,700 for all other taxpayers.
Businesses receiving REIT dividends or PTP income are also eligible to qualify for the QBI deductions. While S corporations and partnerships do not directly qualify for the QBI deduction they can still determine their deductions by reporting their shareholder’s/partner’s share of QBI, W-2 wages, REIT dividends and PTP income.
How is QBI Deduction calculated?
As mentioned earlier, for a business to qualify for the QBI deduction, the taxable income must be at a certain threshold and should be a qualified trade or business. The taxable income is the gross income before the QBI deductions are incorporated. It includes rental income, capital gains, wages paid from other jobs and so on.
Listed below are a few steps that you need to follow to arrive at the QBI calculation.
Step 1- Calculating your taxable income and QBI
The first step would be to calculate the QBI for your respective business and derive the taxable income.
If your business is an SSTB and has taxable income exceeding the specified threshold then your income may be too high to avail the QBI deduction.
However, if your taxable income is between $157,500 and $207,500 ($315,000 and $415,000 if a married couple is filing jointly) then you’ll be able to calculate your limited deduction.
In contrast, if your business’s taxable income falls below $157,500 ($315,000 if a married couple is filing jointly) then there is no need to take into account the type of business you’re running. You will be able to claim the full 20% QBI deduction.
The calculation does not account for the investment based capital gains/losses.
Step 2- Combining QBI sources
Your total QBI would be the sum of all multiple sources of income.
Once you combine the QBI sources from all the different businesses you might own, the next step would be to apply the W-2 wage and qualified property limitations.
Step 3- Calculating the Limitations
In order to calculate the limitation, your business should be eligible under the QBI guidelines while making sure that your taxable income meets the threshold criteria.
To proceed further, you would need to know how much your business paid in W-2 wages and the qualified property it holds.
If your taxable income falls below the threshold, you can directly claim the 20% deduction. Otherwise, it would be limited to the lesser of 20% of QBI OR the greater of 50% that is paid in W-2 wages OR 25% of W-2 wages plus 2.5% of qualified property.
What is meant by W-2 wages in Qualified business income deduction?
W-2 wages are the total amount of wages the company has paid to its employees. They are most commonly subject to tax withholding, employees elective deferrals for contributions made and includes compensation paid to an owner- employee/shareholder of pass-through entities such as S corporations.
What is meant by “UBIA of Qualified property” in Qualified Business Income Deduction?
Qualified property refers to tangible property such as machinery and equipment that is subject to depreciation and is available for use at the close of the tax year.
The basis of qualified property is calculated as the unadjusted basis immediately after acquisition. The depreciation period ends 10 years after it had been placed in service or the last day of the recovery period. Henceforth, it only takes into account property that has not reached the end of its 10 year mark.
For example, a machine will be accounted for 10 years when arriving at the qualified business income deduction.
Does QBI deduction apply to owners having multiple businesses?
If you own more than one business, it is essential to calculate the QBI for each and then sum up the figures that have been calculated.
You may also be able to aggregate businesses to not only include the QBI but also the W-2 wages and the qualified property limitations for each.
However, doing so would mean that you’ll be arriving at larger deductions than if you had calculated the QBI deduction separately for each business and added them together.
Choosing to aggregate the businesses for QBI deduction might mean that they’ll have to meet certain conditions as you’ll be subject to aggregate in coming years too.
In addition, if your QBI calculation from all your businesses is less than zero, the resultant negative amount must be carried forward to next year as well.
The QBI deduction may seem complicated at first. You might need to revisit the rules a few times to gain a fuller grasp of the calculation.
Rest assured, there are plenty of resources out there that provide details applicable to the nature of your work.You wouldn’t want to miss out on QBI deduction that can work for the benefit of your business.
The deduction is intended to reduce the tax rate on QBI of qualified trade/businesses and SSTB’s run by taxpayers whose income falls under the tax threshold.
Luckily, it won’t reduce any business income or impact self-employment tax for people who identify themselves as self-employed owners.
Since it allows you to deduct the lesser of 20% of your qualified business income, you’ll only be paying taxes on 80% of your QBI. Falling under a certain tax bracket can further reduce the effective tax rate for your business.
Thus, working closely with an accountant or a professional advisor can help you garner substantial savings and make the most out of the QBI deduction.