Every penny a small business saves on taxes is important, and the Qualified Business Income (QBI) Deduction lets some business owners remove up to 20% of their income from tax consideration. This can be a major tax deduction if you own a small enterprise, but only if you qualify for it and apply the deduction correctly.
The Tax Cuts and Jobs Act of 2017 (TCJA) created significant alterations to the U.S. tax code, including cuts to individual, corporate, and estate tax rates. The act also:
- Made changes to deductions, expensing, and credits that impact both businesses and individuals
- Nearly doubled the standard deduction amount
- Introduced a new deduction for some self-employed individuals and business owners: The Qualified Business Income Deduction.
The QBI deduction is substantial and helps qualifying businesses lower their tax burden. The Internal Revenue Service (IRS) data showed that over 15 million taxpayers claimed the QBI deduction on their tax returns in its first year, 2018. It continues to help small business owners pay taxes more efficiently and avoid a hefty tax bill and is pertinent as qualifying individuals begin to prepare their 2020 taxes.
This guide will cover what the QBI Deduction is, who qualifies for it, what kind of income is excluded, and limits to be aware of when filing your 2020 taxes.
What is the Qualified Business Income Deduction?
The Qualified Business Income Deduction was created so some business owners could deduct up to 20% of their income from being taxable, thus minimizing their tax burden. The deduction is the lesser of 20% of QBI plus 20% of your qualified REIT dividends and PTP income, or 20% of your taxable income less your net capital gain. This deduction may be taken by qualifying individuals and owners no matter if they take the standard deduction or decide to itemize deductions on their 2020 tax return.
Not everyone eligible for the Qualified Business Income Deduction, however. Specified service trades or businesses (SSTBs) — those in accounting, athletics, consulting, financial services, health services, performing arts, and other industries — do not qualify once they pass the income threshold. If you are over the income limit and an SSTB, you do not qualify for this tax break at all. These types of owners do qualify for the QBI Deduction:
Sole Proprietor
A sole proprietorship is owned and operated by one individual, and there is no legal separation between the owner and the enterprise. This means the individual is liable for its debts or obligations.
Partnership
A partnership is run by two or more parties with mutual interests who share liabilities and profits.
S Corporation
An S Corporation is a closely held corporation that has made an election to be taxed as a pass-through entity.
LLCs
Limited Liability Companies (LLCs) must be treated as sole proprietorships or as partnerships for tax purposes to qualify for the deduction. LLCs are private limited companies that can provide both pass-through taxation and liability protection.
Trust or Estate
Certain trusts or estates may be eligible for the QBI Deduction.
These businesses are known as pass-through entities because the income passes to their individual tax returns instead of being taxed at the corporate income tax rate. If your entity is eligible, the next step is to determine which kinds of income qualify for the deduction.
What Business Income Qualifies as QBI?
Most of the net profit received by the qualifying business qualifies for this deduction. The following types of income do not qualify and are specifically excluded by the QBI Deduction:
- Capital gains, losses, and other investment income.
- Investment dividends, payments in lieu of dividends, or qualified REIT dividends.
- Any interest income that cannot be properly allocated to an enterprise or trade.
- Income Earned Outside the U.S. (all QBI must have been earned in the U.S.).
- Wage income, payments to partners for services outside of their partner capacity, and guaranteed payments from a partnership.
- Any income earned through a C corporation or by providing services as an employee.
Even with those sources excluded, the QBI generally lets the owner deduct a significant portion of the income earned from small enterprise operations. If you’re primarily self-employed, the QBI does not reduce your standard deduction or prevent you from itemizing deductions, either. However, there are important income limits to be aware of, though many have already been increased for 2020 taxes.
Income Limits That Can Disqualify You From the QBI Deduction
You will not be able to take advantage of the QBI Deduction if your income is over certain limits, even if your business qualifies. These limits have increased each year since the deduction was introduced. Here are the QBI thresholds when filing your 2020 taxes in 2021:
- Single filers, heads of household, and married filing separately: The QBI limit is $163,300 to claim the full deduction and $213,300 for a partial deduction.
- Married filing jointly: For married filers, the QBI limit is $326,600 for the full deduction and $426,600 for a partial deduction.
You may be able to claim up to the full deduction if your taxable income is below these income limits. If your income is equal to or higher than these thresholds, your maximum deduction will decrease based on your income. The IRS Form 8995-A helps taxpayers calculate what their deduction will be. The limits will increase to $164,900 for single filers and $329,800 for joint filers for 2021 taxes, which will be filed in 2022.
Get Help with the Qualified Business Income Deduction
Navigating the QBI Deduction and other tax breaks is never easy on your own. Working with a tax professional who can walk you through eligibility requirements and other credits and deductions you may qualify for when filing your 2020 tax return can have a huge impact on your returns.
The team at Silver Tax Group is ready to help with any tax issue you may be facing this year. Our tax attorneys help with emergency tax services, accounting, tax consulting, tax debt resolution, tax fraud investigations, and much more. The COVID-19 pandemic has created new assistance programs, which may have their own set of tax implications, and it is more important than ever to be sure you are filing and recording everything correctly.
Contact Silver Tax Group to speak to a tax expert about the QBI Deduction.
