What is the Qualified Business Income deduction?
This deduction, occasionally referred to as the Section 199A deduction, was created as part of the 2017 Tax Cuts and Jobs Act (TCJA) and became effective in 2018. Qualified pass-through business owners can take tax deductions of up to 20% of their net business income. The QBI deduction only reduces the amount of federal income taxes owed by qualified business owners. it does not reduce Social Security or Medicare tax obligations (self-employment tax) or net investment income tax.
This deduction is available to both taxpayers who itemize their deductions as well as those who use the standard deduction.
Who is eligible to take advantage of the QBI deduction?
In order to claim the QBI deduction and take this tax break, small businesses are subject to two requirements.
First, the business must be a pass-through entity for tax purposes. Pass-through entities include sole proprietorships, partnerships, S corporations, limited liability partnerships (LLPs), certain trusts and estates, and limited liability companies (LLCs). Ultimately, a pass-through business is an entity for which separate tax filings are not required. In other words, the company’s profits or losses are passed through to the individual owners, who are required to report income and pay taxes on that income at their personal tax rates.
The second requirement to take the QBID is that the pass-through business must have qualified business income for the tax period. The IRS defines qualified business income as the “net amount of qualified income, gain, deduction and loss from any qualified trade or business.” QBI does not include capital gains, capital losses, or dividends, interest income not allocable to the business, wage income paid to S corporation shareholders, commodities transactions, foreign currency gains or losses, qualified REIT dividends, PTP income, and certain other types of receipts.
If your business meets both of these requirements and has taxable income for the year, you can generally take the QBI deduction.
Is rental real estate income considered qualified business income for this business deduction?
Generally, yes. Rental income qualifies as qualified business income as long as the property rental activities qualify as a business. If you earn real estate rental income, see IRS Revenue Procedure 2019-38, which provides a safe harbor for determining whether real estate activities can be treated as a trade or business.
QBI also includes real estate investment trusts (REITs), income from publicly traded partnerships (PTP income), and income from certain cooperatives. The qualified REIT/PTP component of the QBI deduction is not limited by a business owner’s W-2 wages and is equal to up to 20% of the qualified REIT and PTP income.
Are there certain types of businesses that are automatically ineligible for the QBI deduction?
Yes. C corporations are ineligible to take the QBI deduction because they are not pass-through entities. C corporations are required to file separate business tax returns and pay taxes at corporate income tax rates. However, the corporate tax rate was permanently lowered under the Tax Cuts and Jobs Act to 21%, so C corporations effectively received tax relief separate from the QBI deduction.
Similarly, the deduction is not available on income earned working as an employee for someone else.
Finally, if your business is categorized as a specified trade or business, as discussed more fully below, you may be ineligible for the deduction when total income exceeds certain levels. These types of businesses generally rely on the reputation or skill of one or more of their employees.
Is the deduction for QBI phased out for certain taxpayers?
The IRS publishes the QBID threshold and phase-in amounts each year. For 2022, the threshold amount is $170,050 for single taxpayers or $340,100 for joint filers. For the 2023 tax year, those amounts increase to $182,100 for single taxpayers and $364,200 if you are married and file a joint return.
If a qualified business owner’s total taxable income for the year is under the threshold amount or established income limitation, the business is generally able to take the QBI deduction. However, certain types of businesses with income that exceeds the threshold amount may not be eligible to take the deduction. High earners in businesses that are considered “specified service trades or businesses” (SSTB), a category including accountants, lawyers, doctors, financial planners, investment management and other financial services professionals, actors/performance artists, athletes, consultants, and certain other professionals, may not qualify for the deduction at all if their income is over the phase-in limit. For 2022, the upper limit is $220,050 for single taxpayers and $440,100 for joint filers ($232,100 and $464,200 for 2023, for single filers and those who are married filing jointly, respectively).
For incomes above these threshold levels, businesses may be able to deduct a smaller percentage of their qualified business income. It is important to note that these amounts represent all taxable income, not just the taxable income earned from a qualified business.
What is the QBI deduction worth to me as a small business owner?
The QBI deduction is potentially quite valuable. For a small business with pass-through income of $100,000, taking the QBID could allow the business to deduct $20,000 from taxable income. In other words, instead of paying income tax on $100,000 in income, the tax bill would be calculated on income of $80,000.
However, the amount of your QBI deduction may be further limited if your business paid W-2 wages to employees. What’s more, if your business holds qualified property, the unadjusted basis of that property after acquisition can further impact the amount of your deduction.
How is the QBI deduction calculated?
Most LLC owners and other qualified businesses use Schedule C to calculate their income and expenses, determining and reporting their adjusted gross income (AGI) on IRS Form 1040. The QBI deduction is calculated after determining your AGI. If your total income is less than the applicable threshold amount, then you can likely claim the maximum deduction of 20% of your QBI. If you are a qualified business and have QBI, it does not matter whether you are engaged in a specified service trade or business as long as your total income is under the threshold amount for the tax year.
For income over the applicable amount, the amount of your available QBI deduction, if any, depends on the nature of your business and on how much over the threshold amount your income was. For a taxpayer whose income is under the threshold amount, the deduction is equal to the lesser of:
- 20% of the taxpayer’s QBI plus 20% of qualified REIT dividends or PTP income.
- 20% of the taxpayer’s taxable income minus net capital gains.
Calculating the QBI deduction can be a challenge, even if your business’s income is relatively straightforward. The IRS provides responses to a series of FAQs designed to help taxpayers navigate the complexity of the QBI deductions. When in doubt, contact a Rocket Lawyer network attorney or your tax professional for help with your specific circumstances.
Are there strategies I can use to reduce my income below the QBID threshold amount?
Because the QBI deduction is determined after you calculate adjusted gross income, there are some potential strategies you could consider if your income exceeds the applicable threshold.
Some taxpayers may find they benefit by implementing retirement plans, making larger retirement plan contributions for the tax year, being more intentional about capital gains and losses, delaying the receipt of Social Security payments or pension payments to reduce net income, or structuring charitable contributions more deliberately. Still other business owners have evaluated the merits of changing their business entity structure around the 2017 Tax Cuts and Jobs Act changes, including the QBID.
Talk to your tax professional or a lawyer to evaluate your situation and determine whether it makes sense for you to take any action regarding your eligibility (or ineligibility) for the QBI deduction.
I am eligible for the deduction. How do I claim it?
You can claim the deduction when filing your individual tax return. For businesses structured as partnerships or S corporations, partners and shareholders can typically rely on the information reported on Schedule K-1 to determine their deduction.
Does the QBI deduction offer permanent tax relief?
As it currently stands, no. The QBI deduction is set to end with the 2025 tax year, meaning business owners who qualify can take the deduction for the last time when they file their 2025 federal income tax returns in early 2026. However, Congress may act to extend the deduction or to make it a permanent part of the tax code.
If you have more questions about your business’s taxes, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.