The qualified business income deduction: How to get it

If you’re a US-based small business owner, the qualified business income deduction (QBI) can be an excellent tax break — if you qualify.

Known also as the Section 199A deduction, it allows eligible business owners to deduct up to 20% of their company’s income. But how do you know if you are eligible for it — and, if so, how do you get it?

In this article, we’ll explain who it applies to, and how to calculate it. So let’s jump straight in.

What is the qualified business income deduction?

The QBI deduction was introduced in 2017 as part of the Tax Cuts and Jobs Act (TCJA), a significant tax reform measure.

Under the act, owners can claim up to 20% of their qualified taxable income under a Section 199A deduction.

Who qualifies for a Section 199A deduction?

The deduction is available to “pass-through” businesses, which are entities whose incomes are not taxed at the corporate level, but on the owners’ individual income tax return. These include sole proprietorships, partnerships, S corporations, and some trusts and estates.

What income can you categorize as QBI?

QBI is defined as your portion of your company’s profits, which is the sum of all your company’s income, gains, deductions, and losses. It does not include the following:

• Wage income

• Investment income, such as capital gains or losses

• Qualified REIT dividends

• Partnership income

• PTP income

• Unallocated interest income to a particular trade or business

• Revenue not directly attributable to the operation of a business within the US

• Reasonable compensation from an S corporation

• Specific dividends and substitute payments for those dividends

• Loss, profit, or deductions resulting from notional principal contracts

QBI thresholds and limitations

Determining your QBI deduction will depend on the following:

• Your total taxable income: this includes wages from other jobs, wages earned by your spouse, capital gains, interest and dividends, rental income, and more.

• Your type of business: i.e, whether you have a specified service trade or business (SSTB) or a non-SSTB.

Note: SSTBs refer to businesses whose main asset is the skill or reputation of their owners or employees. They can include companies and professions in the medical, legal, accounting, consulting, and sport fields.

If your taxable income is at or below the income limit shown above, you can claim the full 20% deduction. It doesn’t matter if your business is an SSTB or not. 

As a result, your QBI deduction becomes the lesser of:

• 20% of your Section 199A income, or;

• 20% of your modified taxable income.

If you have a taxable income between $191,951 and $241,950 (for single filers), or $383,900 and $483,900 (if filing jointly), you may be eligible for a QBI deduction based on your business type.

If your taxable income lies within this range and your business is an SSTB, you are eligible for a partial deduction.

How to determine your QBI deduction

While you can find information on how to determine your QBI on IRS Form 1040, you can also find instructions on Forms 8995 and 8995-A. These provide information on who can claim the deduction, how to find qualifying businesses and income, specific exclusions, and more.

Here are the main steps for calculating QBI deductions:

1. Determine if your company falls under the SSTB category

The type of entity you own can have a big impact on your eligibility. As discussed earlier, you can’t claim a QBI deduction unless you have a pass-through entity.

2. Determine your total annual taxable income

Next, you need to establish your taxable income and QBI. Your total taxable income is all of your income before the QBI deduction. This is the adjusted gross income that you will see on Form 1040. 

Your QBI is also the total of all the qualified income, gains, deductions, and losses for a qualified business or trade.

3. Assess your qualified property limitations and W-2 wages

When determining the QBI deduction, “qualified property” means any depreciable tangible property that:

• Is held and used by the qualified trade or business during the tax year

• Is used to make the QBI at any point during the tax year

• Can lose value over time but not before the end of the tax year

Once you’ve determined your taxable income, qualified property limitations, and W-2 wages, you can figure out your QBI deduction.

When doing this, consider the following:

If your taxable income is at or below the threshold in the table above, you are eligible for the full 20% QBI deduction, whether you are an SSTB business or not.

If your taxable income is between the phase-in range ($191,951 to $241,950 for single filers or $383,900 to $483,900 for joint filers) and you’re an SSTB, your QBI deduction applies to the phase-in of SSTB and wages (or qualified property limitations). If you are a non-SSTB, the QBI deduction applies to the phase-in of wages (or qualified property limitation).

If your taxable income exceeds the limits and you’re an SSTB, there is no QBI deduction. If you’re not an SSTB, the QBI deduction applies to the W-2 wages (or qualified property limitation).

Examples of QBI deductions

To illustrate, here are some examples:

Paul is a business owner whose taxable income is below the threshold, and is a single filer. He earns a taxable income of $100,000 from a qualified trade or business. As a result, he can claim a QBI deduction of $20,000 (20% of $100,000).

Anja is a business owner whose taxable income is above the threshold, but her business is not classed as SSTB. She files jointly with her husband. She earns $400,000 in taxable income and $200,000 in QBI from her non-SSTB. She can claim a QBI deduction limited by the W-2 wage and capital limitation.

Yusuf earns above the threshold and owns an SSTB. He is a single filer. He earns $300,000 in taxable income from a law practice. As a result, he would face a phased-out deduction.

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