What is the QBI deduction?
We will go through a subject that makes people the most happy and creates good surprises for those who do not know this. It is a nice application that allows you to deduct 20% more from your net income after deducting all costs and expenses.
The qualified business income deduction (QBI) also called Section 199A is a tax break that allows eligible self-employed and small-business owners to deduct up to 20% of their qualified business income. The deduction is available, regardless of whether taxpayers itemize deductions on Schedule A or take the standard deduction. It’s in effect for tax years 2018 through 2025. The qualified business income deduction is for people who have “pass-through income” that’s partnership (1065), S corporation (1120-S), trust or estate (1041) and a domestic business managed as a sole proprietorship (Schedule C).
Well, are there any occupational classification or AGI limits to take advantage of this deduction? In advance, let’s say they both have. The first thing we need to know is what is QBI, Qualified business income is the net income of the business, with a few exceptions such as dividend, capital gains or losses, interest income, income earned outside the U.S., certain wage and guaranteed payments made to partners/shareholders.
The second thing we need to know is the separation of Qualified Trade/Business (“QTB”) and Specified Service Trade/Business (“SSTB”). An SSTB is a trade or business involving the performance of services in the fields such as health, law, accounting and so on. In short, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. QTB is any business other than SSTB.
Things can get a little complicated when it comes to implementing the QBI because limits and other restrictions come into play.
- Overall limitation is %20 of taxable income, and according to taxable income in 2021 the limits are $164,900 – $214,900 for single filers and $329,800 – 429,800 for joint filers. These limits are crucial for calculating of QBI deduction as related to phase-in/out on a pro-rated basis.
- If taxable income is subject to phase in/out and it is an QTB,
The QBI deduction is the greater of:
– 50% of the amount of W-2 wages paid to employees by the qualified business
or
– The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property (UBIA).
- If taxable income is subject to phase in/out and it is an SSTB, It will benefit from reduced QBI/W2 calculation.
There are three options in computing of QBI deduction
I. If taxable income is under the limit, $164,900 for single filers and $329,800 for joint filers. No matter whether your business are QTB or SSTB, you will take advantage of the full 20% deduction.
An example; you have $125,000 in taxable income (single) including $110,000 in QBI earned through an SSTB (or QTB). QBI deduction is $22,000 ($110,000 x 20%)
II. If taxable income is above the limit, $214,900 for single filers and $429,800 for joint filers.
- If your business is SSTB, no QBI deduction
- If your business is QTB, QBI deduction will phase out as per your taxable income
An example; you have $254,900 in taxable income (single) including $140,000 in QBI earned through a QTB. W2 wages $40,000 and UBIA $150,000
The QBI deduction is the greater of:
– 50% of the amount of W-2 wages / ($40,000 x 50% = $20,000)
or
– The sum of 25% of W-2 wages plus 2.5% of UBIA. ($40,000 x 25% + $150,000 x 2.5%= $13,750)
As a result, QBI deduction is $20,000, but watch out, make sure QBI deduction calculated don’t exceed the overall limit. If it exceeds, you have to take the calculated amount in overall limit.
III. If taxable income is in between the limits, 164,900 – $214,900 for single filers and 329,800 – $429,800 for joint filers.
- If your business is QTB, QBI deduction will phase out as per your taxable income
An example; you have $184,900 in taxable income (single) including $110,000 in QBI earned through a QTB. W2 wages $40,000 and UBIA $150,000
Step 1; (184,900 – 164,900)/50,000 = 40% (50k, phase in-out range, $164,900-$214,900)
Step 2; Tentative QBI deduction; 110,000 x 20% = $22,000
Step 3; The QBI deduction is the greater of:
-50% of the amount of W-2 wages ($40,000 x 50% = $20,000)
or
-The sum of 25% of W-2 wages plus 2.5% of UBIA. ($40,000 x 25% + $150,000 x 2.5%= $13,750)
Step 4; (Tentative QBI – QBI deduction) x Phase-in range %
($22,000 – $20,000) x 40% = $800
Step 5; $22,000 – $800 = $21,200 QBI deduction
- If your business is SSTB;
An example; you have $184,900 in taxable income (single) including $110,000 in QBI earned through a SSTB. W2 wages $40,000.
Step 1; (184,900 – 164,900)/50,000 = 40% (50k, phase in-out range, $164,900-$214,900)
Step 2; 100% – 40% = 60% (Both QBI and W2 will be reduced with this %)
Step 3; computing of the reduced QBI and W2 amounts;
– Reduced QBI: $110,000 x %60 = $66,000
– Reduced W2: $40,000 x %60 = $24,000
Step 4; select the lesser of;
– QBI deduction per QBI: $66,000 x 20% = $33,000
– QBI deduction per W2: $24,000 x 50% = $12,000 QBI deduction
