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The qualified business income (QBI) deduction, also known as Section 199A or pass-through deduction, allows eligible self-employed individuals and pass-through entity owners to deduct up to 20% of qualified business income on their personal tax returns. The deduction aims to provide substantial tax relief for small business owners and self-employed individuals, resulting in greater savings compared to claiming the standard deduction.
The Internal Revenue Service (IRS) has set specific reporting criteria for QBI that determine the eligibility for the deduction. For instance, the total taxable income in 2023 for single filing must be under $182,000 and $364,000 for joint filers. For 2024, the limit for taxable income is raised to $191,950 for single filing and $383,900 for filing jointly. If your income exceeds these thresholds, you must carefully navigate IRS rules that qualify you for partial or full deduction.
While the qualified business income deduction offers significant tax benefits, navigating the IRS rules on qualification, eligibility criteria, and calculations can be complex and challenging. Here’s a simplified breakdown of how Qualified Business Deduction works:
Determining Your Qualification for QBI Deduction
The qualified business income (QBI) deduction is available to taxpayers with "pass-through" income from a business reported on their personal tax return. To qualify for the deduction, you must be an active participant in the trade or business activities of the following pass-through entities:
Sole proprietorships - income is reported on Schedule C of the business owner's personal tax return.
Partnerships - income is passed to partners, reported on Schedule E of personal tax returns.
S corporations - income is passed to shareholders, reported on Schedule E of personal tax returns.
Limited liability companies (LLCs) - income is passed to members, reported on Schedule E of personal tax returns if the LLC is taxed as a partnership or S corporation.
What is QBI?
While the QBI deduction provides a valuable tax break for business owners, it has limitations on the types of income that can qualify. It specifically applies to "qualified business income", which is defined by the IRS as the net amount of income, gain, deduction, and loss from a qualified trade or business. In simpler terms, QBI is generally the net profit from a qualified business.
However, not all business income is counted as QBI. Therefore, you must carefully determine whether your income is excluded when calculating your eligible QBI deduction amount. The following types of income are specifically excluded from QBI and do not qualify for the deduction:
- Capital gains or losses
- Dividends and interest income
- Income earned from business activities outside the United States
- Certain payments made to partners in a partnership or shareholders in an S-corporation, such as:
- Guaranteed payments to partners for services rendered
- Compensation to shareholders from an S-corp
About Form 8995
Form 8995 is the Internal Revenue Service form used by owners of pass-through entities to claim the qualified business income (QBI) deduction on their personal tax returns. These entities include sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations.
The QBI deduction was first introduced with the Tax Cuts and Jobs Act (TCJA) of 2017. A major component of the TCJA was reducing the corporate tax rate to 14%. However, this tax cut only applied to C corporations, which account for just 5% of small businesses in the United States. In response, legislators developed the QBI deduction for pass-through entities to provide comparable tax savings. Without the creation of this deduction, over 95% of small businesses would have been excluded from the tax relief intended by the TCJA. The QBI deduction, claimed on Form 8995, now allows eligible owners of pass-through entities to deduct up to 20% of their qualified business income on their personal tax returns, providing substantial tax savings for non-C corporation small businesses.
What are SSTBs and Non-SSTBs?
Specified service trade or businesses (SSTBs) are service-based businesses that rely heavily on the skill and reputation of their employees and owners. SSTBs exclude engineering and architecture but generally include businesses in law, health, consulting, performing arts, athletics, accounting, investment management, and financial services. The distinction is important because the qualified business income deduction has limitations and phase-outs for taxpayers with income over certain thresholds from an SSTB. While SSTBs are eligible for the deduction, there are limitations for non-SSTBs over the income thresholds, ensuring the deduction has guardrails. Here are the eligibility criteria for SSTBs and Non-SSTBs:
For SSTBs (2023)
|
Filing status |
Total taxable income |
Available deduction |
|
Single , married filing separately, and heads of household |
< $182,100 |
20% |
|
Single , married filing separately, and heads of household |
$182,100 – 232,100 |
Partial deduction for SSTBs |
|
Single , married filing separately, and heads of household |
> $232,101 |
No deduction for SSTBs |
|
Married Filing Jointly |
< $364,200 |
20% deduction |
|
Married Filing Jointly |
$364,201 - $464,200 |
Partial deduction for SSTBs |
|
Married Filing Jointly |
> $464,201 |
No deduction for SSTBs |
Non-SSTBs (2023)
|
Filing status |
Total taxable income |
Available deduction |
|
Single , married filing separately, and heads of household |
< $182,100 |
20% deduction |
|
Single , married filing separately, and heads of household |
$182,100 – 232,100 |
20% deduction |
|
Single , married filing separately, and heads of household |
> $232,101 |
Limited Deduction |
|
Married Filing Jointly |
< $364,200 |
20% deduction |
|
Married Filing Jointly |
$364,201 - $464,200 |
20% deduction |
|
Married Filing Jointly |
> $464,201 |
Limited Deduction |
If your business is not classified as SSTB but your total taxable income surpasses $232,100 (single filing) or $464,200 ( married couples filing jointly), your QBI deduction will be limited and must be adjusted to the the greater of:
- 50% of your share of W-2 wages paid by the business, or
- 25% of your share of W-2 wages plus 2.5% of qualified property like tangible depreciable assets.
How to Calculate your QBI Deduction
Following these key steps can help you determine your eligibility and maximize the potential amount for the QBI deduction:
Step 1: Determine if your business is classified as a specified service trade or business (SSTB) based on IRS guidelines. Refer to the IRS website for the full list.
Step 2: Calculate your total taxable income for the year after applying all deductions and exemptions. If your taxable income is below $182,100 as a single filer or $364,200 as a joint married filer, you qualify for the full 20% QBI deduction.
Step 3: If your business is classified as an SSTB by the IRS and your taxable income exceeds $232,100 (single) or $464,200 (joint), you cannot claim the QBI deduction.
If your business is not considered an SSTB and your total taxable income falls between $182,100 and $232,100 as a single filer (or between $364,200 and $464,200 married filing jointly), you can qualify for the full 20% QBI deduction.
If your business is (SSTB) and your total taxable income as a single filer falls between $182,100 and $232,100 (or between $364,200 and $464,200 filing jointly, you may qualify for a limited qualified business income deduction.
Step 4: If your business is an SSTB and your income falls between the lower and upper thresholds ($182k to $232k single or $364k to $464k joint), calculate your QBI deduction as 20% of qualified business income, limited to the greater of:
- 50% of your share of the business's W-2 wages paid to employees, or
- 25% of W-2 wages plus 2.5% of qualified property like depreciable business assets.
The Bottom Line
Navigating the complexities of the Qualified Business Income (QBI) deduction can be an arduous task, particularly with complex IRS rules, eligibility criteria, and nuanced calculations. Attempting to file QBI deduction individually may present challenges, making the process both time-consuming and error-prone. However, with the right expertise you can unlock substantial savings and breathe easy during tax season. NSKT offers professional Tax services to help you achieve the full potential of this tax benefit. Our dedicated and experienced Tax professionals ensure timely and accurate filings, helping you claim all eligible deductions to maximize your savings.
The information provided here is for general informational purposes only and should not be construed as professional advice. The tax-related content on this blog is based on our understanding of tax laws as of the date of publication and may be subject to change.
