The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a new tax deduction for qualified business income (QBI) for pass-through entities such as partnerships, S corporations, sole proprietorships, and certain real estate investment trusts (REITs). The QBI deduction is available for tax years 2018 through 2025 and allows eligible taxpayers to deduct up to 20% of their QBI from their taxable income.
What is QBI?
QBI is the net amount of income, gain, deduction, and loss from a qualified trade or business operated in the United States, excluding certain investment-related items such as capital gains and losses, dividends, and interest income. QBI is determined separately for each qualified trade or business and can only be claimed by eligible taxpayers.
What are the reporting requirements for the QBI deduction?
Taxpayers must report their QBI and QBI deduction on their individual income tax return using Form 1040 and Form 8995 or Form 8995-A. Pass-through entities must also report QBI and related information to their owners on Schedule K-1.
Who is eligible for the QBI deduction?
Individuals, trusts, and estates that own a pass-through entity or sole proprietorship that generates QBI are eligible for the QBI deduction. However, certain limitations and exclusions apply based on the type of business and the taxpayer’s income.
In general, total taxable income in 2022 must be under $170,050 for single filers or $340,100 for joint filers to qualify. In 2023, the limits rise to $182,100 for single filers and $364,200 for joint filers.
If you’re over the income limit
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”?
Tests for pass-through businesses over the income limit
If your business is a “specified service trade or business” in 2022 and your income is from $170,050 to $220,050 (single filers) or from $340,100 to $440,100 (joint filers), there are some tests to determine whether you can claim the qualified business income deduction, and, if so, whether it’ll be reduced.
The same goes if you own a business with pass-through income that’s not a “specified trade or business”: There are tests that determine how much you can claim of the deduction. Specifically, the amount of your deduction is based on a calculation tied to the amount of wages you paid to employees (including yourself), as well as the value of the property the business owns. The higher those figures, the better your chances of being able to qualify for the deduction.
If you don’t have a specified service trade or business
If your business is not an SSTB, but you have taxable income greater than the income limits of $220,050 for a single filer or $440,100 for a married couple being joint filers, your QBI deduction is limited to the greater of:
- 50 percent of your share of the W-2 wages paid out in the business, or
- 25 percent of your share of the W-2 wages paid out in the business, plus 2.5 percent of qualified property
Qualified property includes all tangible, depreciable property that hasn’t reached the end of its depreciable life. For most properties, the depreciable life is 10 years. For real estate, the depreciable life may be up to 39 years.
For both SSTBs and non-SSTBs
If the business owner has dividends from a qualified real estate investment trust, publicly traded partnership income in the tax year, there is a second deduction worth up to 20 percent of that income, which gets added to the QBI deduction. After calculating the two deductions, add them together. Then calculate your overall limitation by taking 20 percent of:
- Your taxable income for the tax year (before considering the QBI deduction), minus
- Net capital gains, including qualified dividend income taxed at capital gains rates
This overall limitation ensures that the 20 percent deduction isn’t taken against income that is already taxed at the lower capital gains tax rate.
Who qualifies for the qualified business income deduction?
The qualified business income deduction is for people who have “pass-through income” — that’s business income that you report on your personal tax return.
- Sole proprietorships
- S corporations.
- Limited liability companies
- Capital gains or losses.
- Interest income.
- Income earned outside the U.S.
- Certain wage and guaranteed payments made to partners and shareholders
How the qualified business income deduction works?
There are a couple of aspects of the pass-through deduction to keep in mind:
There are actually two 20% figures. The qualified business income deduction is worth up to 20% of your taxable business income. But it’s also true that when claiming this pass-through deduction, it can’t add up to more than 20% of your total taxable income.
Here’s how it works: You figure your business income and expenses on Schedule C, as normal. And you figure your adjusted gross income on Form 1040, as usual. Only after that do you start calculating this pass-through deduction.
2. You can claim the qualified business income deduction even if you don’t itemize. That is, if you use the standard deduction, this deduction is still available to you.
How to calculate the QBI deduction
The best way to figure out whether it applies to your business is to take it step-by-step.
Step 1: Determine whether your business is a specified service business. The IRS Qualified Business Income goes into greater detail about the kinds of businesses that qualify as an SSTB.
Step 2: Calculate your total taxable income for the year. If a taxpayer’s taxable income is less than $170,050 ($340,100 if married filing jointly) then no matter the type of business, they can take the full 20 percent QBI deduction.
Step 3: If your business is an SSTB and your total taxable income is $220,050 or more ($440,100 or more for a married couple filing jointly), stop here. Your income is too high to claim the deduction.
If your business is not an SSTB, and you’re total taxable income is between $170,050 and $220,050 ($340,100 and $440,100 if married filing jointly), you can claim the full 20 percent deduction.
If your business is an SSTB and your total taxable income is between $170,050 and $220,050 ($340,100 and $440,100 if married filing jointly), then continue to the next step to calculate your limited deduction.
Step 4: If your business is an SSTB with income in the phase-out range, you’ll calculate your deduction by taking 20 percent of your qualified business income and applying the limitation of:
50 percent of your share of W-2 wages paid by the business, or
25 percent of those wages, plus 2.5 percent of your share of qualified property
Compare these calculations to 20 percent of your QBI and deduct the smaller amount.
Give you an example of how the QBI deduction works in the real world, say Kate is a marketing consultant with $10,000 in qualified property. She has one part-time employee who earns $20,000 per year. Kate is married, and as a consultant, she is in a specialized service business. Let’s look at three scenarios:
Kate’s total taxable income is less than $340,100, so her deduction is not limited,
Kate’s total taxable income is more than $340,100 but less than $440,100, so her deduction is limited, and
Kate’s total taxable income is more than $440,100, so no deduction is available.
|Particular||No Limitation||Limited Deduction||No Deduction|
|QBI (before limit)||$75,000||$75,000||$75,000|
|Subject to QBI Limit?||No||Partial||Yes|
|QBI (after limit)||$75,000||$11,250||$0|
|Amount of W-2 Wages||$20,000||$20,000||$20,000|
|Subject to the wage limit?||No||Partial||No|
|Allowable business deduction||$15,000||$1,612.50||$0|
The taxable income limits for 2022 are:
|Filing status||Total taxable income||Available deduction|
|Single||$170,050 – 220,050||Partial deduction for SSTBs|
|Single||> $220,050||No deduction for SSTBs|
|Married Filing Jointly||< $340,100||20% deduction|
|Married Filing Jointly||$340,100 – $440,100||Partial deduction for SSTBs|
|Married Filing Jointly||> $440,100||No deduction for SSTB|
The taxable income limits for 2023 are:
|Filing status Total taxable income Available deduction Single < $182,100 20% Single $182,100 – 232,100 Partial deduction for SSTBs Single > $232,100 No deduction for SSTBs Married Filing Jointly < $364,200 20% deduction Married Filing Jointly $364,200 – $464,200 Partial deduction for SSTBs Married Filing Jointly > $464,200 No deduction for SSTB|
In conclusion, the QBI deduction is a valuable tax break for eligible pass-through entity owners and sole proprietors. However, the rules and limitations can be complex, and taxpayers should consult with a qualified tax professional to determine their eligibility and calculate their QBI deduction.