The Tax Cuts and Jobs Act (“TCJA”) passed late in 2017 introduced a new deduction for business owners. Individuals who own and/or operate qualified business activities can deduct up to 20% of their qualified business income. This deduction can result in dramatic tax reductions in some cases. Like most of the rest of the Internal Revenue Code, these rules are extremely complicated. The following is a brief overview of the basic concepts.
Who is or isn’t eligible?
You may be asking yourself, “can I claim this deduction?” If you are one of the following, you may be able to take the deduction, subject to some limitations which we’ll discuss later.
- Sole proprietors
- S-corporation shareholders
- Partners or members in partnerships
Unfortunately, C-corporations and employees are not allowed to take this deduction.
Additionally, in some cases, service trades or businesses (“SSTB”) may be phased out entirely from the deduction. SSTBs are businesses where the primary revenue generators are lawyers, accountants, health professionals, financial professionals, actuarial sciences, athletics, consultants, performing arts, etc.
Qualified business income (“QBI”) is made up of the taxable income, gain, deduction, and loss from any qualified trade or business. It also includes REIT dividends. It includes neither S-corporation shareholder-owner reasonable compensation, nor guaranteed payments to partners.
Limitations: There are many limitations applied when calculating the qualified business income deduction (“QBID”)
Wage / Qualified Property Limitation:
The QBID is first limited to greater of 50% of W-2 wages, or 25% of wages plus 2.5% of unadjusted basis of qualified property. The picture shown on the right is a simplified representation of the income thresholds to which the Wage and Qualified Property limitation applies for both an SSTB and everyone else. For those whose income falls in the green portion of the picture, this limitation is disregarded entirely. In the yellow range, there is a phase-in of the limitation for “everyone else” and a phase-out of the deduction for an “SSTB”. In the red portion, the full limitation is applied to “everyone else” and an “SSTB” is no longer entitled to any portion of the QBID.
Taxable Income Limitations
After all calculations are completed, the overall QBID is further limited to 20% of taxable income. For this limitation, capital gains are disregarded.
The QBID rules are incredibly complicated, but with the right help and knowledge it could benefit you. If you think you might qualify, or if you have questions, contact DKB to learn more.