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Monday, September 6, 2021

Qualified Business Income Deduction

 

The qualified business income (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 that 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.)  The deduction was created to level the playing field between pass-through entity and corporations.

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.

Qualified business income (QBI) is essentially your share of profits from the business. It is the net amount of income, gain, deduction, and loss from your business.

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.  In 2020 Married filing jointly is $326,600, Head of Household $163,300 and Married filing separately $163,300.

Here’s an example: Your taxable income is $160,000, of which $70,000 is QBI. You simply multiply QBI ($70,000) by 20% to figure your deduction ($14,000).

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:

1.     20% of QBI.

2.     (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.

Another limitation, 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. 

There are several other scenarios for specific service trade or business.  Also farm and horticulture cooperatives have special formulas.

To further review current IRS resources have been referenced below.

IRS resources:

Qualified Business Deduction

IRS QBI facts