The qualified business income deduction can reduce your tax bill by 20%

The qualified business income (QBI) deduction can save business owners whose income is remitted to their personal income tax up to 20% on their taxes. Find out how to deduct this transfer below.

One of the new tax rules that business owners should be aware of is this Deduction for qualified business income (QBI). The deduction, also called Section 199A, a A 20% deduction is available to qualifying pass-through businesses such as sole proprietorships, S corporations, and partnerships (not C corporations). By default, limited liability companies (LLCs) are taxed as pass-through business entities, so they can also take advantage of the QBI deduction if they elect to be taxed as a C corporation.

Like many tax rules, this deduction is more complicated than it first appears, so let’s start with the basics and then dig a little deeper for those of you who want to take a closer look at the potential savings.

Here are three facts you should know about transitional deduction and what? As for:

  • It is not based on the definition of business income as most of us are used to. Instead, it uses “qualified business income” (QBI) to calculate any deductions you may be entitled to.
  • There is an income-based limit on the amount of the deduction.
  • Certain types of businesses, referred to in the new tax law as Special Service Trades or Businesses (SSTBs), are not eligible for the deduction once certain income thresholds are met.

Let’s look at each of these rules as they apply to independent businesses.

  • QBI, from the IRS’s point of view, is equal to the income you earn from your pass-through business minus any net capital gains or short-term capital losses. (A pass-through business is one where business income is reported and taxed only on the owner’s individual tax return without being taxed at the business level first.) In addition, QBI does: no includes income from W-2 wages received from an S-corporation or guaranteed payments from a partnership.

    The amount you can deduct is also subject to either 50% of the wages your business pays to employees or 25% of wages plus 2.5% of the basis of the business’s qualified property, whichever is higher. These calculations should be compared to 20% of your QBI; then you can withdraw the amount that is less. This limit also phases in between $321,400 and $421,400 for joint filers in the same taxable income range.

  • The income-based limitation applies to non-corporate taxpayers who exceed the $321,400 income threshold. If you own a personal services business (called a specified service business), your QBI amount is phased out on a pro rata basis when your total taxable income reaches $421,400. At this income level and above, you no longer qualify for the 20% deduction benefit. Businesses that are not special service businesses are still subject to the deduction.
  • A service trade or business, as defined by the IRS, is any trade or business that provides services in health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and others. Also included are any trade or business involving investment and investment management, trading or trading in securities. Engineers and architects are not defined as a special service trade or business and are therefore excluded from this restriction.
  • Capital-intensive businesses were taken into account under the new law by raising the salary cap to include a qualifying property count. According to the IRS, qualified property is tangible depreciable property used by your business to earn QBI. These deductions can be made on your individual return and calculations will be applied everyone a business that you operate separately.

So how should business owners calculate the 20% QBI pass-through deduction?

First you need to determine if your business is an SSTB as stated above. The first two examples below assume that your business is no SSTB. In both cases, you must calculate qualified business income (QBI) from your business. This is simply the net income of your business, excluding any wages, salaries or payments made to you, the owner. If you are self-employed, this will be your income on Schedule C.

  • If your business is below the income exclusion threshold described above, you simply calculate 20% of the transferable income from your business(es) and take the deduction as long as it is less than 20% of your taxable income. except. net capital gains.
  • If your business is not an SSTB and you exceed the maximum income threshold, your calculation is more complicated to account for the phase-out of the deduction.

You must determine the ratio of income you can have outside the $160,700 limit for single taxpayers and $321,400 for married filing jointly.

Also note that if your taxable income reaches $210,700 (single) or $421,400 (married filing jointly), the QBI deduction is limited to 50% of your W-2 wages from that business or W-2 in the amount of 25%. wages from the business plus 2.5% of any qualified property. Then, using the income threshold above and the $210,700/$421,400 phase-out amount to prorate the limitation.

Here’s an example of how to do this, assuming:

  • You have $425,000 in taxable income (married, filing jointly), including $300,000 in QBI earned through a non-SSTB LLC.
  • You paid two employees a total of $100,000 in W-2 wages.
  • You own the building in which your office is located, which has an unadjusted cost basis of $250,000.

Given this hypothetical situation, your maximum transfer is 20% of your $300,000 QBI, which equals $60,000. Because your taxable income exceeds $421,400, any carryover deduction you claim is limited to the greater of (i) 50% of the W-2 wages paid to your employees or (ii) 25% of the W-2 wages plus 2.5%. % of your office building based on $250,000. (i) is $100,000 (50% x $100,000) = $50,000; (ii) is (2.5% x $250,000) + (25% x $100,000) = $31,250. Because (i) is greater than (ii), you must take the smaller amount of $31,250 as a pass-through deduction.

A trade or business in unspecified services will calculate the deduction as follows:

For our example, let’s assume:

  • You are a consultant (one of the categories of service providers subject to phase-out restrictions) and a single taxpayer with taxable income of $233,015.
  • Your taxable income is $72,315 or 45% more than the single filer income threshold.
  • You paid your employees $60,000 in wages.

To calculate, multiply your deduction by the phase-out. in this case, it is limited to 50% of your W-2 wages paid because there is no qualifying property. This equals $30,000 (50% x $60,000 W-2 salary = $30,000). If your itemized deduction percentage is 45%, you get 55% of the full deduction, which is equal to 55% x $30,000 = $16,500.

This new pass-through deduction can offer significant tax savings for your business, but it’s also somewhat complicated. Could it save you 20%? Maybe it depends on how the specific rules for this deduction apply to your situation. This is where engaging a tax professional for tax planning and calculations can be helpful. Whether you choose to work with a tax professional or go it alone, it’s worth considering whether this tax deduction will affect your tax bill this year.

The carry-over reduction is in effect until 2025.

Disclaimer: The content on this page is for informational purposes only and does not constitute legal, tax or accounting advice. If you have specific questions about any of these topics, seek the advice of a licensed professional.

Related to: LLC v. S-Corp

Source link