The government is generally “nice” to businesses in terms of their tax liability. In fact, the corporate tax rate is as low as it has ever been. Large enterprises are really benefiting. But what about the little guy? Well, there is help out there for us too – in the form of the Qualified Business Income deduction (QBI).
Exactly What Is the Qualified Business Income Deduction?
The QBI is a tax reduction allowance for small business owners. It is important to understand, though, that this is not a business tax rate deduction.
This deduction only applies to people who include their personal income from the companies when filing their personal tax returns. Qualified business income deduction applies to:
- sole proprietorships
- S corporations.
So that makes quite a lot of people eligible! Another important bit: this is a temporary benefit. It expires in 2025 unless Congress acts to extend it.
The deduction is 20% of your personal income, taken off the top – before you enter your other deductions or pay your self-employment tax. It sounds really simple, right? Not so fast. As always, the devil is in the details when it comes to tax preparation. And not every self-employed individual will qualify.
How Do You Qualify for QIB?
There are a couple of important criteria:
First, your adjusted gross income must be below $321,400-$421,400, if filing jointly, or $160,700-$210,000 singly.
Here is a simple example that will show the value of this deduction.
A sole proprietor architect earns $300,000. He and his wife file jointly, and she does not work. Before any other deductions are added in, he takes 20% off that income, or $60,000. His adjusted gross income is now $240,000. Given that the new marginal tax rate is 32%, he has saved $60,000 X .32 = $19,000 on his tax bill.
So far – so good! But there are some important caveats when it comes to figuring out the QIB eligibility. Let’s take a look at some of the details and exceptions that apply.
First, the good news:
- Business owners can use the deduction for income from certain investments. For example, if your business income comes from real estate investments, certain dividends from cooperatives and certain publicly-traded partnerships, you will qualify.
- Landlord income can also qualify if you are not a totally passive landlord, and there are rules you need to understand for that.
Now, some bad news. There are certain types of businesses that may not qualify. These are called Specified Service Trades or Businesses (SSTB). In general, these are businesses whose activity in providing services in the following sectors:
- Actuarial science
- Performing arts
- Most financial and investment services
Interestingly, architects and engineers were exempted. And, business owners cannot use capital gains (losses), interest income, or income earned outside the U.S. As well, if the qualifying incomes increase beyond the qualifying level, the 20% deduction does phase out.
And here’s another little wrinkle – If you are in one of the exempted SSTB’s, but you have other business income (e.g., you are also a landlord), then that part of your business income will qualify.
Already feeling confused? Probably so. But let’s take a quick look at how the QBI deduction is actually calculated to establish more clarity!
How to Calculate Qualified Business Income Deduction
The actual calculation is not too awful. First, you must remember that it is based on your adjusted gross income, not your total gross income.
- Do your Schedule C first – your allowable business tax deductions
- Then do our 1040 as normal
- At the bottom, you get your adjusted gross income.
These steps are what you do every year.
Then go to the “Qualified Business Income Deduction Worksheet” provided by the IRS. There are two income tests, which are pretty self-explanatory.
If the personal income from a business falls below the limits listed above, the regular 20% applies. If it is above the limits, there are two income tests that a business owner may use, which will give him a reduced deduction.
Obviously, the QBI deduction is complex. You have to be certain that your income is from a qualifying business, even in part. If you are one of the exempted service providers, you can still get the deduction in some instances. And, if your income is higher than the limitations, you will need to complete the two-income tests to see what you do qualify for.
The best advice? This is a great deduction for a business owner and it should not be ignored. But, your best bet is to get with a tax professional, so that it is done right and you get all that you are entitled to!
Photo by Kelly Sikkema