Are you eligible to take the deduction for qualified business income (QBI)? Here are 10 facts about this valuable tax break, referred to as the pass-through deduction, QBI deduction, or Section 199A deduction.
1. It is available to owners of sole proprietorships, single member limited liability companies, partnerships, and S corporations. It also may be claimed by trusts and estates.
2. The deduction is intended to reduce the tax rate on QBI to a rate that is closer to the corporate tax rate.
3. It is taken ‘below the line.’ That means it reduces your taxable income but not your adjusted gross income. But it is available regardless of whether you itemize deductions or take the standard deduction.
4. The deduction has two components: 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate; and 20 percent of the taxpayer’s combined qualified real estate investment trust dividends and qualified publicly traded partnership income.
5. QBI is the net amount of a taxpayer’s qualified items of income, gain, deduction, and loss relating to any qualified trade or business. Items of income, gain, deduction, and loss are qualified to the extent they are effectively connected with the conduct of a trade or business in the U.S. and included in computing taxable income.
6. QBI does not necessarily equal the net profit or loss from a business, even if it is a qualified trade or business. In addition to the profit or loss from Schedule C, QBI must be adjusted by certain other gain or deduction items related to the business.
7. A qualified trade or business is any trade or business other than a specified service trade or business (SSTB). But an SSTB is treated as a qualified trade or business for taxpayers whose taxable income is under a threshold amount.
8. SSTBs include health, law, accounting, actuarial science, certain performing arts, consulting, athletics, financial services, brokerage services, investment, trading, dealing securities, and any trade or business where the principal asset is the reputation or skill of its employees or owners.
9. There are limits based on W-2 wages. Inflation-adjusted threshold amounts also apply for purposes of applying the SSTB rules. For tax years beginning in 2021, the threshold amounts are $164,900 for singles and heads of household; $164,925 for married filing separately; and $329,800 for married filing jointly. The limits phase in over a $50,000 range ($100,000 for a joint return). This means that the deduction reduces ratably, so that by the time you reach the top of the range ($214,900 for singles and heads of household; $214,925 for married filing separately; and $429,800 for married filing jointly) the deduction is zero for income from an SSTB.
10. For businesses conducted as a partnership or S corporation, the pass-through deduction is calculated at the partner or shareholder level.
As you can see, this substantial deduction is complex, especially if your taxable income exceeds the thresholds discussed above. Other rules apply as well, so contact us if you have questions about your situation.