The Qualified Business Income Deduction (QBI) : Explained!

Understanding the Qualified Business Income Deduction: Who Can Take It?

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced several changes to the U.S. tax code, one of the most significant being the Qualified Business Income (QBI) deduction. This deduction was designed to provide tax relief for owners of pass-through entities such as sole proprietorships, partnerships, S corporations, and some trusts and estates. The QBI deduction allows eligible taxpayers to deduct up to 20% of their qualified business income, potentially reducing their overall tax liability. Here’s a closer look at what the QBI deduction is, who qualifies for it, and how it works.

What Is the Qualified Business Income Deduction?

The Qualified Business Income deduction, also known as the Section 199A deduction, is available to taxpayers who have income from a qualified trade or business. The deduction is a significant tax break because it allows business owners to deduct up to 20% of their qualified business income from their taxable income. This deduction is in addition to the standard deduction or itemized deductions.

Qualified business income generally includes the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. However, it does not include items such as capital gains or losses, dividends, interest income, or wages earned as an employee.

Who Can Take the QBI Deduction?

The QBI deduction is available to owners of pass-through entities. A pass-through entity is a business structure that allows income to "pass through" to the owners or investors. The income is then taxed at the individual level rather than at the corporate level. This includes:

• Sole Proprietorships: Individuals who run their own businesses without forming a separate legal entity.

• Partnerships: Businesses owned by two or more people where profits and losses are passed through to the partners.

• S Corporations: Corporations that pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

• Some Trusts and Estates: Certain trusts and estates can also benefit from the QBI deduction.

In addition to these, eligible taxpayers must meet specific criteria related to income levels, business type, and other factors.

Income Limits and Phase-Outs

The QBI deduction is subject to income limitations and phase-outs. For the tax year 2023, if your taxable income is below $182,100 for single filers or $364,200 for married couples filing jointly, you can generally take the full 20% QBI deduction.

However, if your taxable income exceeds these thresholds, the QBI deduction may be subject to limitations, particularly if you are in a specified service trade or business (SSTB). SSTBs include fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset is the reputation or skill of one or more employees or owners.

For those above the income threshold but not in an SSTB, the deduction is limited to the lesser of:

1. 20% of qualified business income, or

2. The greater of:

   • 50% of W-2 wages paid by the business, or

   • 25% of W-2 wages paid by the business plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

If you are in an SSTB and your income exceeds the phase-out range ($232,100 for single filers and $464,200 for joint filers in 2023), the QBI deduction is entirely phased out.

Calculating the QBI Deduction

Calculating the QBI deduction can be complex due to the various factors and limitations involved. Here’s a simplified example:

Suppose you own a sole proprietorship with $100,000 in qualified business income, and your total taxable income (including business income) is $150,000 as a single filer. Since your income is below the threshold, you are eligible for the full QBI deduction.

Your QBI deduction would be 20% of $100,000, or $20,000. This means you can reduce your taxable income by $20,000, leading to significant tax savings.

Who Cannot Take the QBI Deduction?

While the QBI deduction is available to a wide range of business owners, some individuals and income types do not qualify. Specifically:

• C Corporations: These entities are taxed at the corporate level, so their income is not eligible for the QBI deduction.

• Employees: Wages earned as an employee do not qualify as QBI.

• Investment Income: Income such as capital gains, dividends, and interest income is not considered qualified business income.

Conclusion

The Qualified Business Income deduction is a powerful tool for reducing taxable income, providing significant tax savings for eligible business owners. However, the rules surrounding the deduction are complex, particularly for those with income above the threshold or those operating in a specified service trade or business. It’s crucial for business owners to understand these rules and consult with a tax professional to ensure they maximize their QBI deduction while remaining compliant with tax laws