Navigating the New Qualified Business Income Deduction

Navigating the New Qualified Business Income Deduction

Robert Newton, CPA, CVA

The tax reform legislation that Congress signed into law on December 22, 2017, was the largest change to the tax system in over 3 decades. The new tax code contains many provisions that will affect individual, estate, and corporate taxpayers. One of those changes includes the Qualified Business Income Deduction, a new tax benefit allowing entrepreneurs, self-employed individuals and investors to deduct 20 percent of their business income. It is an important factor to consider when deciding whether the structure of your business will be a pass-through entity or a C Corporation. In this article, we are providing an overview of how the deduction works.

What is QBI and how does it work?

QBI is income earned from a sole proprietorship, S Corporation, or partnership. It does not include wages earned as an employee. Simply put, the QBI deduction permits eligible taxpayers to deduct 20 percent of their qualified business income. The deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026.

Qualified Business Income Deduction Eligibility

Eligible

  • Trust and Estates
  • Individuals
  • Partnership
  • S Corporation
  • Sole Proprietor

Non-Eligible

  • C Corporations 
  • Employee Wages

Who Qualifies?

Calculating the QBI deduction depends on whether a business is considered a “specified service.” A Specified Service Trade or Business (SSTB) is any trade or business that involves the performance of services included in the fields of:

  • Health
  • Law
  • Accounting
  • Actuarial science
  • Performing arts
  • Consulting
  • Athletics
  • Financial services
  • Brokerage services
  • Trades or business involving investing and investment management
  • Or any trade or business "where the principal asset of such trade or business is the reputation or skill of 1 or more of the its employees."

How is it Calculated?

There are a few steps, rules, and thresholds that have to be evaluated before you are finally determined to be entitled to the deduction.

If your business IS NOT a “specified service” business (see listing above), and your taxable income is less than $315k (MFJ - Married Filing Joint), the deduction is simply 20% of the net income passed out and reported on your personal income tax return.

  • If your taxable income is greater than $315k (MFJ), there is a second threshold to calculate involving W2 wages of the business and unadjusted basis of fixed assets.  If the 20% calculation is less than 50% of the W2 wages, then you will get the deduction in full.  If the 20% calculation is more than 50% of the W2 wages, you are entitled to a deduction totaling the greater of 1) 50% of W2 wages or 2) 25% of W2 wages plus 2.5% of the unadjusted basis of qualified fixed assets.
  • The taxable income threshold for those with a filing status of Single is one-half of the taxable income threshold for those with a Joint (MFJ) filling status.

If your business IS a “specified service” business (see listing above), the calculation has different tests/thresholds. 

  • If your taxable income is less than $315k (MFJ), then you are entitled to the 20% deduction in full.
  • If your taxable income is between $315k and $415k (MFJ), then there is a phase-out of the 20% deduction.
  • If your taxable income is above $415k (MFJ), the 20% deduction is not available.
  • The taxable income threshold for those with a filing status of Single is one-half of the taxable income threshold for those with a Joint (MFJ) filling status.

The QBI deduction can get even more complicated. For example, rental real estate may qualify as a business for QBI if, as a landlord, you have more responsibility than just collecting payment each month. However, if the tenant of your rental real estate activity is your “specified service” business and your overall taxable income is greater than the allowed thresholds, the 20% deduction will not be allowed on the rental activity income.

Determining whether your business is or isn’t an SSTB and properly planning for the thresholds will be critical for your 2018 tax returns.  To discuss your future options regarding the QBI deduction, call us today.