What is the qualified business income deduction?
One of the more significant provisions of the Tax Cuts and Jobs Act, passed in December of 2017, is the Section 199(a) deduction. Section 199(a) of the Internal Revenue Code provides many taxpayers a deduction for up to 20% of Qualified Business Income (QBI) from a qualified trade or business operated directly by the taxpayer or through business entities known as a pass-through entities (i.e. S-Corporation, partnerships, etc.).
In general, total taxable income in 2020 must be under $163,300 for single filers or $326,600 for joint filers to qualify. In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers. If you’re over that limit, complicated IRS rules determine whether your business income qualifies for a full or partial deduction.
Who qualifies for the deduction?
The 199(a) deduction is for people who have “pass-through income” — that’s business income that you report on your personal tax return.
Entities eligible for the qualified business income deduction include:
· Sole proprietorships
· S corporations
· Limited liability companies (LLCs)
You must have "Qualified Business Income"
The 199(a) deduction by definition applies to "Qualified Business Income," or QBI. Qualified Business Income is defined as "the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business." Broadly speaking, that means your business's net profit.
But it also means that not all business income qualifies. QBI excludes:
· Capital gains or losses
· Interest income
· Income earned outside the U.S
· Certain wage and guaranteed payments made to partners and shareholders
Your income level matters
If your total taxable income — that is, not just your business income but other income as well — is at or below $163,300 for single filers or $326,600 for joint filers, then in 2020 you may qualify for the 20% deduction on your taxable business income. In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers.
But if your income is above these limits, things get more complicated.
Here’s why, above those income limits your ability to claim the pass-through deduction depends on the nature of your business activity. And even if your business qualifies, there’s a chance you won’t get to enjoy the full 20% tax break, as the qualified business income deduction is phased out for some businesses.
If you’re over the income limit
First, if a taxpayer’s income is below income limit, the SSTB limitation does not apply.
For taxpayers whose taxable income is within the phase-out range, the taxpayer’s share of qualified business income, W-2 wages, and UBIA of qualified property related to the SSTB may be limited.
If a taxpayer’s taxable income exceeds the phase-out range, no deduction is allowed with respect to any SSTB.
If you’re over the income limit, there are a few tests that determine whether you qualify for the qualified business income deduction. One such test is this: Is your business a “specified service trade or business"?
If you’re a doctor, lawyer, consultant, actor, financial planner — and the list goes on — then your business is deemed a “specified service trade or business,” and many high earners in these fields won’t qualify for this tax break, because it disappears once you hit total taxable income of $213,300 if you’re single, and $426,600 if you’re married filing jointly.