How the Qualified Business Income Deduction can impact your return
Signed into law in December 2017, the Tax Cuts and Jobs Act changed the playing field with a significant qualified business income deduction for a “qualified trade or business,” excluding corporations. This new deduction is equal to 20% of a taxpayer’s “qualified business income” (QBI).
QBI is calculated by netting the total amount of qualified income, gain, deduction and loss from any qualified trade or business. This only includes items that are taxable income and are connected with a trade or business in the United States. Capital gains and losses, certain dividends and interest income are some of the excluded items.
Who this helps
Thanks to the new Section 199A of the tax code, owners of sole proprietorships, S corporations and partnerships may be eligible for increased tax breaks. This allows owners of pass-through entities to now claim the deduction on an individual return. Overall, federal income tax is decreased but self-employment taxes for the purposes of the alternative minimum tax are not reduced.
While there is little change on the cooperative level, which impacts farmers, trust and estates may also qualify. However, despite the updated law, there are exceptions to what is considered a “qualified trade or business.” According to the IRS, if taxable income exceeds $315,000 for a married couple or $157,500 for an individual, as of 2018, those working in the following fields will be excluded from this deduction:
- Actuarial science
- Performing arts
- Financial services
- Investing and investment management
Limitations on the deduction
If your income is less than the specified amount in a service business, then you will be able to deduct the lesser of:
- 20% of your QBI, plus 20% of your qualified REIT dividends and qualified PTP income, or
- 20% percent of your taxable income minus your net capital gains.
To make sure the deduction is not taken from income taxes at preferential rates, the limit of the deduction for a non-service business is the lesser of these numbers:
- 20% of QBI, or
- Greater of half of the individual’s W-2 wages from the qualified business or sum of one-quarter of the W-2 wages from the qualified business, plus 2.5% of the unadjusted basis after the acquisition of qualified property.
The resulting deduction is then subject to a second limitation equal to 20% of the excess from the taxable income for the year over the sum of net capital gain.
This article was last edited on September 22, 2021.