by Gregory S. Dowell
February 7, 2019
One of the most lucrative tax benefits under the Tax Cuts and Jobs Act (TCJA), and one of the most challenging to calculate in certain cases, is the qualified business income deduction (QBID). This deduction is available to individuals who have qualified business income from S corps, partnerships, LLCs, or sole proprietorships. This has been referred to by a number of names, such as QBID, pass-through income deduction, and the 20% deduction for business income.
The deduction is generally equal to 20% of the “qualified business income” (QBI) from a partnership, S corporation, LLC, or sole proprietorship. QBI is defined as the net amount of items of income, gain, deduction, and loss with respect to a trade or business. The business must be conducted within the U.S. to qualify, and specified investment-related items are not included, such as capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). The trade or business of being an employee does not qualify. Also, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership’s business.
The deduction is taken “below the line,” which means that it reduces taxable income but not adjusted gross income. It is available regardless of whether one itemizes deductions or takes the standard deduction. In general, the deduction cannot exceed 20% of the excess of taxable income over net capital gain. If QBI is less than zero it is treated as a loss from a qualified business in the following year.
Rules are in place (discussed below) to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction.
These rules involve “thresholds,” that is taxable income of over $157,500 ($315,000 for joint filers). If taxable income is at least $50,000 above the threshold, or at least $207,500 ($157,500 + $50,000), all of the net income from a specified service trade or business is excluded from QBI. Joint filers would use an amount $100,000 above the $315,000 threshold, or $415,000. For taxable incomes that are between the threshold amounts and the $207,500/$415,000 amounts, the exclusion from QBI of income from specified service trades or businesses is phased in. Specified service trades or businesses are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners.
Additionally, for taxpayers with taxable income more than the above thresholds, there is a limitation on the amount of the deduction that is based either on wages paid or wages paid plus a capital element. Here’s how it works: If taxable income is at least $207,500 ($415,000 for joint filers), the deduction for QBI cannot exceed the greater of (1) 50% of the allocable share of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate). For taxable incomes that are between the threshold amounts and the $207,500/$415,000 amounts, a phase-in of the limitation applies.
Other limitations may apply in certain circumstances, for instance, in the cases of taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
Obviously, the complexities surrounding this substantial new deduction can be formidable, especially if taxable income exceeds the thresholds discussed above. The issue is best studied on a case-by-case basis when a taxpayer has pass-through income.