What is the qualified business income deduction?
The Tax Cuts and Jobs Act created a new “qualified business income deduction,” which is a 20% pass-through tax deduction for the self-employed and small-business owners. In general, if your total taxable income was under $157,500 for single filers or $315,000 for joint filers in 2018, you may qualify for the deduction. If you’re over that limit, there are complicated IRS rules that determine whether your business qualifies and whether you get a full or partial deduction — or none at all.
Here’s how the qualified business income deduction generally works.
You must have a “pass-through” business
The qualified business income deduction is for people who have “pass-through income” — that’s business income that you report on your personal tax return.
Entities eligible for the qualified business income deduction include:
- Sole proprietorship s.
- S corporations.
- Limited liability companies (LLCs).
You must have “qualified business income”
The qualified business income deduction by definition applies to “qualified business income,” or QBI. Qualified business income is defined as “the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business.” Broadly speaking, that means your business’s net profit.
But it also means that not all business income qualifies. QBI excludes:
- Capital gains or losses.
- Interest income.
- Income earned outside the U.S.
- Certain wage and guaranteed payments made to partners and shareholders.
Your income level matters
If your total taxable income — that is, not just your business income but other income as well — for 2018 is at or below $157,500 for single filers or $315,000 for joint filers, then you probably qualify for the 20% deduction on your taxable business income.
“For those taxpayers, it actually is fairly easy,” says Jacob Kuebler, a certified financial planner and owner of Bluestem Financial Advisors in Champaign, Illinois.
But if your income is above these limits, now’s the time to reach for a bottle of aspirin.
Here’s why: Above those income limits, your ability to claim the pass-through deduction depends on the precise nature of your business. And even if your business qualifies, there’s a chance you won’t get to enjoy the full 20% tax break, as the qualified business income deduction is phased out for some businesses.
“It’s once you start getting into those higher-income brackets that you have to start thinking more about the nature of your business,” Kuebler says.
If you’re over the income limit
If you’re over the $157,500 (or $315,000 for joint filers) limit, there are a few tests that determine whether you qualify for the qualified business income deduction. One such test is this: Is your business a “specified service trade or business”?
If you’re a doctor, lawyer, consultant, actor, financial planner — and the list goes on — then your business is deemed a “specified service trade or business,” and many high earners in these fields won’t qualify for this tax break, because it disappears once you hit total taxable income in 2018 of $207,500 if you’re single, and $415,000 if you’re married filing jointly.
“It’s easier for the non-service businesses to qualify,” says Tim Steffen, director of advanced planning at Baird, a financial services company. “With a service business, you might lose access to the deduction just because of the nature of what you do.”
Tests for pass-through businesses over the income limit
If your business is a “specified service trade or business” and your income is from $157,500 to $207,500 (single filers) or from $315,000 to $415,000 (joint filers), there are some tests to determine whether you can claim the qualified business income deduction, and, if so, whether it’ll be reduced.
The same goes if you own a business with pass-through income that’s not a “specified trade or business” and your taxable income tops $157,500 (single filers) or $315,000 (joint filers): There are tests that determine how much you can claim of the deduction.
Specifically, the amount of your deduction is based on a calculation tied to the amount of wages you paid to employees (including yourself), as well as the value of the property the business owns.
The higher those figures, the better your chances of being able to qualify for the deduction.
But it gets complicated, and fast. So if your tax situation falls into this area, now might be a good time to consult a tax professional. Or check out the IRS regulations for more details.
There are “enough complicated issues that it’s something you might want to discuss with your tax advisor rather than trying to figure out the deduction on your own,” says Mark Luscombe, a principal analyst at Wolters Kluwer Tax & Accounting.
How the qualified business income deduction works
There are a couple of aspects of the pass-through deduction to keep in mind:
1. There are actually two 20% figures. The qualified business income deduction is worth up to 20% of your taxable business income. But it’s also true that when claiming this pass-through deduction, it can’t add up to more than 20% of your total taxable income.
Here’s how it works: You figure your business income and expenses on Schedule C, as normal. And you figure your adjusted gross income on Form 1040, as usual. Only after that do you start calculating this pass-through deduction.
On Form 1040, “the qualified business income deduction goes on line 9, after adjusted gross income and separate from Schedule C,” Luscombe says.
2. You can claim the qualified business income deduction even if you don’t itemize. That is, if you use the standard deduction, this deduction is still available to you, Luscombe says. (Here’s how much the standard deduction is worth in 2019.)