The Qualified Business Income (QBI) deduction is one of the most significant changes of the Tax Cuts and Jobs Act of 2017 (TCJA). It is also one of the most complex. In general, it permits a 20% deduction of net income to owners of small businesses like partnerships, S Corps and sole proprietorships as well as dividends from REITs, income from publicly traded partnerships (PTPs) and certain payments from COOPs. The QBI deduction is subject to numerous limitations and rules.
Simple example: you are the sole owner of an S Corp, which has net income of $100,000 in 2018. Normally you would report the entire $100,000 as taxable income on your personal tax return. However, starting in 2018 you get a deduction of 20% so you end up paying taxes on only $80,000. This effectively reduces your tax rate on this income by 20% also.
So long as your total household income is below certain limits ($157,500-207,500 for individuals or $315,000-$415,000 for couples), then the QBI deduction generally applies to some extent, no matter the business type. Household income is calculated at the individual/couple level, not the business level. Thus, other sources of income, like wages, can push you above the limit. This doesn’t mean you lose the QBI deduction, but certain limitations to the QBI deduction and how it is calculated may come into play.
Specific service type businesses do not qualify for the QBI deduction if your household income exceeds the upper limits mentioned above. These services types are health, medical, law, accounting, consulting, performing arts, athletics, financial services, investment management and other personal service type businesses. If your total household income is below the limit, then you may still qualify for at least a partial, and possible full QBI deduction, even if you own a personal service type business.
If total household income is above the limit and your business is not a specific service type business, then you can still qualify for the QBI deduction, so long as you pay W2 wages to employee(s) in your business and/or you own a certain level of qualified property in your business. The rules, limitations and calculations here become extremely complex.
Even though this is a complex new tax law, the QBI deduction can provide significant tax savings to small business owners. Call anytime to discuss how this new deduction may affect you and your small business.