Thanks to tax reform legislation passed in December 2017, eligible taxpayers may now deduct up to 20 percent of certain business income from qualified domestic businesses, as well as certain dividends. Eligible taxpayers can claim the deduction for the first time on the 2018 federal income tax return they file in 2019.
Note: Although the final regulations have not yet been published in the Federal Register, taxpayers who wish to become familiar with the rules may review the proposed regulations issued by visiting the IRS website or calling the office.
The Qualified Business Income Deduction (QBID) often referred to as the 20 percent deduction for pass-through entities, is officially known as the Section 199A deduction after Section 199A of the Internal Revenue Code.
Here are six key facts about the qualified business income deduction:
1. The deduction applies to qualified business income from a qualified business (i.e. pass-through entities) such as:
- a sole proprietorship
- LLC treated as a sole proprietorship or partnership for tax purposes
- Non-corporate taxpayers such as trusts and estates
- Publicly traded partnerships
2. Qualified business income is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. Only items included in taxable income are counted. Qualified business income does not include income from performing services as an employee. Capital gains and losses, shareholders wages, certain dividends, and interest income are excluded as well.
3. The deduction is available to eligible taxpayers, whether they itemize their deductions on Schedule A or take the standard deduction.
The deduction can be taken in addition to the standard or itemized deductions and is subject to limitations based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by the trade or business.
4. The deduction is generally equal to the lesser of these two amounts:
- Twenty percent of qualified business income plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income.
- Twenty percent of taxable income computed before the qualified business income deduction minus net capital gains.
5. For taxpayers with taxable income computed before the qualified business income deduction that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction may be subject to additional limitations or exceptions. These are based on the type of trade or business (see below), the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business, and the unadjusted basis immediately after acquisition of qualified property held by the trade or business.
6. Income earned through a C corporation is not eligible for the deduction.
7. Qualified Trade or Business. A qualified trade or business is any trade or business except one involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, 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. This exclusion only applies, however, if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
While relatively straightforward for most businesses, those with more complicated tax structures or multiple businesses or trades, consulting a tax professional is advised. As always, don’t hesitate to call if you have any questions.