One of the most talked about changes to come out of the Tax Cuts and Jobs Act passed at the end of 2017 is the new Qualified Business Income Deduction that was created under Section 199A. In general, the deduction equals 20% of Qualified Business Income (QBI) and is generally available to owners of pass-through businesses, such as sole proprietorships, LLCs and S-Corporations. There are, however, limitations for Specified Service Businesses and an overall limitation on the business owner’s taxable income. In addition, if the business owner’s taxable income is greater than a certain threshold, some additional limitations may apply or the deduction may be disallowed altogether.
Does Your Business Qualify?
First, let’s define a “specified services business.” According to the IRS, a specified service business is “any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.” The IRS specifically excludes architects and engineers from the definition of a specified service business. If the business is a specified service business, then in general, the QBI deduction is not allowed.
Does Your Income Qualify?
There is an exception if the taxpayer’s taxable income is below $315,000 (for MFJ). If that is the case, then a deduction equal to 20% of the QBI is allowed, even if the business is a specified service business. If the taxpayers taxable income is above $315,000 but below $415,000, then a reduced deduction would still be allowed. If the taxpayer’s taxable income is over $415,000 (for MFJ), then no deduction is allowed at all for the owner of a specified service business.
If the business is not a specified service business, then in general, the deduction is 20% of the QBI. However, there are some additional limitations that may apply if the taxpayer’s taxable income is over $315,000 (for MFJ). If the taxpayer’s taxable income is between $315,000-$415,000, then the QBI deduction is still allowed, but is reduced. If the taxpayer’s taxable income is over $415,000, then they are allowed a deduction that is equal to the lesser of:
A. QBI x 20%, or
B. The greater of
• W-2 wages x 50%, or
• W-2 wages x 25% + 2.5% of unadjusted basis
Additionally, regardless of whether the business is a specified service business or not, the deduction is always subject to an overall limitation of 20% of the taxpayer’s taxable income.
We’ve included a link to a flow chart that we find helpful to use in determining how to calculate the Qualified Business Income Deduction under various scenarios. If you need help calculating yours, don’t hesitate to reach out to us!