Did you know that you may be entitled to a tax deduction that doesn’t cost you anything or require you to do anything?
You don’t have to buy anything. You don’t have to perform some action. You get this special tax break, called the qualified business income deduction (QBI deduction), simply by qualifying for it due to the nature of your business and your business income.
1. What’s the qualified business income deduction?
The qualified business income deduction, or QBI deduction, is a personal deduction limited to owners of pass-through entities. These are sole proprietorships (including independent contractors), partnerships, limited liability companies, and S corporations, which are entities in which owners report their share of business income on their personal returns.
The QBI deduction is up to 20% of QBI from a pass-through entity conducting a trade or business in the U.S. (It also includes up to 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income.)
However, as you’ll see, there are many limitations that may prevent you from taking a qualified business income deduction.
The QBI deduction is a personal write-off that you can claim whether you take the standard deduction or itemize personal deductions. The QBI deduction does not reduce business income or have any impact on self-employment tax for owners who are treated as self-employed individuals.
2. What counts as qualified business income (QBI)?
Qualified business income (QBI) is essentially your share of profits from the business. But more specifically, it is the net amount of income, gain, deduction, and loss from your business.
So, there are many adjustments to basic profit or loss to this amount in order to arrive at QBI. In figuring QBI, do not take into account:
- Compensation paid to an S corporation owner-employee, guaranteed payments to partners, or any payments received by partners for services other than in the capacity of partner.
- Investment items, such as capital gains or losses, or dividends.
- Interest income that’s not business interest. Thus, interest on outstanding receivables is taken into account, but interest on a bank account is not.
- Business carryovers that were disallowed before 2018 (such as a home office deduction carryover).
QBI must be reduced by income or deductions related to business income even though they aren’t reported on a business return. These include:
- Gain from transactions reported on , which includes gain from the sale of business property.
- The deduction for one-half of self-employment tax.
- The self-employed health insurance deduction.
- The deduction for contributions to a self-employed SEP, SIMPLE, or other qualified retirement plan.
- Unreimbursed partnership expenses claimed by a partner on his or her personal return.
3. Does taxable income matter when calculating the QBI deduction?
The amount of your taxable income (before the qualified business income deduction is factored in) for the year determines whether you can claim the full QBI deduction or whether certain limitations come into play to reduce or prevent the deduction. The taxable income limit is adjusted annually for inflation:
|Married filing jointly||$321,400||$326,600|
|Head of household/single||$160,700||$163,300|
|Married filing separately||$160,725||$163,300|
Here’s an example: Your taxable income is $150,000, of which $60,000 is QBI. You simply multiply QBI ($60,000) by 20% to figure your deduction ($12,000).
If taxable income exceeds the limit for your filing status, then a special formula is used to figure the deduction. The QBI deduction is the lesser of 1 or 2, below:
- 20% of QBI.
- (a) 50% of W-2 wages (explained below), or (b) 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property (also explained below). You can use either (a) or (b), whichever is more favorable.
There’s one more limitation you can’t overlook. Whatever your QBI deduction turns out to be, it can’t be more than 20% of your taxable income without the QBI deduction. You just have to run the numbers to determine the qualified business income deduction. An additional limitation for a specified service trade or business is explained later.
Note: There’s a special formula for patrons of agricultural or horticultural cooperatives that’s not discussed here.
4. What does “W-2 wages” mean for the qualified business income deduction?
These are total wages that your business paid to employees, including employees’ elective deferrals for contributions to 401(k) plans. It includes reasonable compensation paid to an S corporation owner-employee (even though such compensation isn’t part of QBI).
If you are a partner, a member in a multimember LLC, or an S corporation shareholder, your share of W-2 wages is reported to you on the Schedule K-1 provided to you by your business.
5. What does “unadjusted basis of qualified property” mean when calculating the QBI deduction?
The unadjusted basis of qualified property (UBIA) is the basis of tangible property, such as equipment and machinery, without regard to depreciation or other write-offs. But only take into account such property that has not reached the end of the depreciable period or 10 years after it’s been placed in service, whichever is later.
For example, you buy office furniture, which has a 7-year recovery period for depreciation. You only take this property into account for 10 years when calculating your QBI deduction.
6. Can I still claim the QBI deduction if I have multiple businesses?
If you own more than one business, figure the QBI deduction for each, and then total up the results. As mentioned earlier, any positive and negative QBI are netted.
You may be able to “aggregate” businesses so that items — QBI, W-2 wages, and UBIA — are added together in figuring the deduction. Doing so may result in a larger deduction than if you’d figured the deduction separately for each business and then added them together.
Complicated rules govern the ability to aggregate businesses, taking into account ownership interests and other factors. But one rule is clear: You can’t aggregate specified service trades or businesses (I’ll explain later).
7. How does the qualified business income deduction affect self-employment tax?
Because the QBI deduction is a personal deduction and not a business deduction, it has no effect on self-employment tax. This tax is figured whether or not any QBI deduction can be claimed.
8. What is considered specified service trade or business for the qualified business income deduction?
A specified service trade or business (SSTB) is a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.
Of course, most businesses depend on the reputation or skill of employees and owners. Thus, to decide whether this amounts to an SSTB for the QBI deduction, the principal asset of a trade or business is considered the reputation or skill of its employees or owners only if the trade or business consists of one of the following:
- The receipt of income from endorsing products or services.
- The use of an individual's image, likeness, voice, or other symbols associated with the individual's identity.
- Appearance at events or on radio, television, and other media outlets.
Take this example of a well-known chef who owns a restaurant and also endorses a line of cookware. The restaurant is not an SSTB, but the money he receives from the endorsements constitutes an SSTB.
If you are in an SSTB but your taxable income is below the limit discussed earlier, you get the full QBI deduction like any other business owner. In effect, it doesn’t matter that you’re in an SSTB.
However, if your taxable income is higher, you are subject to an additional limit. In applying the formula discussed earlier, each item in the formula — QBI, W-2 wages, UBIA — is phased out. If taxable income is high enough, there’s a full phase-out so that no QBI deduction can be claimed.
9. What is my QBI if my business isn’t profitable?
If you have more than one business, you net the income and losses. If the total QBI from all of your businesses is less than zero, then you have a negative amount that must be carried forward to the next year, as explained above.
10. How can I learn more about the QBI deduction?
The details about applying the QBI deduction to your situation aren’t easy to grasp. Fortunately, the deduction is figured for you if you use a paid tax return. If you want to get a better understanding of this important deduction, you can review as well as instructions to the tax forms — and — used to claim the deduction.
A final word on the qualified business income deduction
The Treasury Inspector General for Tax Administration filed for 2018 that didn’t take the qualified business income deduction even though it appeared they qualified. Be sure you look into this valuable write-off. If you have any questions, consult with a CPA or other tax advisor.