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Managed Accounting, Tax Accounting

Maximize Your Savings: Navigating the Qualified Business Income Deduction (QBID)

Posted on April 26, 2024

By Michele Roletter

May 25, 2024

Small businesses, entrepreneurs, and individual taxpayers are constantly looking for ways to lower their tax bills, especially if they are reporting business income. Unless you make quarterly estimated tax payments, business income generally isn’t taxed until you file your annual tax return.

Lowering your tax liability relies on maximizing deductions, one of which is the Qualified Business Income Deduction (QBID). The 2017 Tax Cuts and Jobs Act passed provisions known as Section 199A that allow certain business owners and REIT investors to take an automatic 20% deduction on applicable earnings.

This is huge for small business owners and individuals earning high levels of REIT dividends, helping reduce taxable income by up to 20%. In this article, we’ll explore the QBID in more detail, including who is eligible, how to calculate your deduction, and what the future holds for Section 199A.

If you still have questions about your eligibility or how to claim the QBID, reach out to an accounting firm that offers tax services, such as KDG.

Understanding the QBI Deduction

The Qualified Business Income Deduction applies to sole proprietorships, partnerships, s corporations, and some trusts and estates. C corporations are specifically excluded from taking the deduction because all taxes are paid at the entity level. The goal of the QBID is to alleviate a portion of the tax burden for pass-through entities, or businesses that pass down income individual tax returns. This deduction has two components:

  1. QBI Component – This component of the deduction equals 20% of the qualified business income from a domestic business. The QBID can be limited by W-2 wages paid, taxable income, and the unadjusted basis of property.

  1. REIT/PTP Component – This component applies to individuals who earn qualified REIT dividends through a regulated investment company or income from a publicly-traded partnership. In both cases, the deduction is equal to 20%. Unlike business income, REIT and PTP income is not limited to W-2 wages or the unadjusted basis of property but can be limited by capital gains.

Pass-through businesses, like partnerships and s corporations, will report the deduction on Schedule K-1. Then, the taxpayer will claim the deduction on their individual income tax return on Form 8995. Sole proprietorships and single-member LLCs that report income on Schedule C will also claim the deduction on Form 8995. Estates and trusts can either pass the deduction down to beneficiaries or take the deduction at the entity level if income is retained.

Eligibility Part 1: Qualified Businesses vs Specified Service Businesses

There are several different layers of eligibility that businesses and taxpayers must meet to qualify for the QBID. First, the business income must be from a qualified trade or business. A qualified trade or business is any business that falls within the parameters of Section 162, with three notable exceptions: C corporations, a business performing services as an employee, and specified service trades or businesses (SSTBs).

A SSTB is a business that provides services in the fields of health, accounting, law, actuarial science, consulting, athletics, financial services, investing, and performing arts. Any business that relies on an employee’s reputation or skill, accepts endorsements, or is involved with an individual’s image or likeness can be considered a specified service trade or business. Accounting firms that offer bookkeeping services should be able to tell you if you fall within these parameters.

Businesses that have a component of income that falls under the SSTB definition are subject to the de minimis rule. This rule states that businesses with gross receipts less than $25 million must have less than 10% of their income be from specified services to be treated as a qualified trade or business. For businesses with gross receipts over $25 million, less than 5% of income must be from specified services.

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Eligibility Part 2: Income Thresholds and Phase-Out Limitations

Qualified trades or businesses are not subject to income limitations, but businesses that are considered a specified service trade or business do have to abide by income regulations. For the 2023 tax year, single filers can take the full 20% deduction if taxable income is below $182,100. This threshold is increased to $364,200 for married filing joint taxpayers.

Once these thresholds are reached, the deduction begins to phase out until the taxable income is $232,100 for single filers or $464,200 for married filers. Once these taxable income thresholds are passed, the QBID is not allowed for SSTBs. Remember, these limits only apply to SSTBs. Qualified trades or businesses aren’t subject to taxable income limitations.

Flow chart explaining the qualified business income deduction for married and single taxpayers, including income thresholds and specifics on business types.

Calculating the Deduction

Calculating the QBID involves a few different steps. Here’s what you can expect:

Step #1: Determine QBI

The first step is to determine the amount of qualified income or loss. QBI only includes income attributed to business operations. For example, if your business operates in the manufacturing industry, dividend and interest income would not qualify.

Qualified business income will be reduced for certain items, including the deductible portion of self-employment tax, the self-employed retirement contribution deduction, the self-employed health insurance deduction, business charitable contributions, interest expense, and unreimbursed partnership expenses.

Step #2: Review Limits

Next, you will need to review the limits related to QBID. If you determine the income is service based, such as an accounting firm or financial service business, you will need to follow the income limits outlined in the Eligibility Part 2 section. SSTBs will also be subject to the same W-2 and property limitations as a qualified trade or business, which we will cover below.

If your business income is a qualified trade or business, you may still be subject to limits, particularly in W-2 wages paid and property acquired. The QBID is limited to the greater of 50% of W-2 wages paid or the sum of 25% of W-2 wages paid and 2.5% of the unadjusted basis of property (UBIA).

Qualifying property, according to the QBID, is any tangible depreciable property that is available for use in the qualified trade or business, used to produce the QBI during the tax year, and has a depreciable period that does not end during the current tax year. Property is considered qualifying for 10 years. This means the 2023 tax year would only include property acquired in 2013 or later.

Let’s go through a W-2 and UBIA limit example. Your share of W-2 wages is $1,000,000, your UBIA is $2,500,000 and your QBI is $750,000. Using the first method, your QBI limit would be 500,000 ($1,000,000 * 50%). Using the second method, the limit would be $312,500 ($1,000,000 * 25% + $2,500,000 * 2.5%). Since the limit applies to the higher calculation, your QBI would be limited to $500,000.

It’s also important to note that the QBID only applies to income. If your business has a loss, you are not able to claim the QBID and the loss will be applied to future periods with income. For example, if you have a $20,000 loss in one year and $50,000 of QBI in the next year, your QBI base will be $30,000.

Step #3: Calculate Your QBID

Once you have your QBI, you will apply the 20% deduction. Using the above example, your deduction will be $100,000, which is 20% of $500,000. This $100,000 is a deduction from adjusted gross income, helping you lower your tax base.

SSTB Example

Now, let’s look at a SSTB example. Let’s say that you have $100,000 of SSTB income. You file as a single taxpayer with $202,100 of taxable income. You paid $75,000 in W-2 wages and your UBIA is $500,000. Here’s how you will calculate the QBID:

  1. Calculate Phase-In Percentage – First, take your $202,100 of taxable income and subtract it from the full limit threshold of $182,100. This gives you $20,000. Now divide the $20,000 by the phase-out limit of $50,000. This tells you that 40% of your QBI is disallowed.

  1. Determine QBI Deduction – Next, you will need to calculate the other limits.

Unadjusted QBI = $12,000 ($100,000 * 20% * 60%)

50% of W-2 wages = $22,500 ($75,000 * 50% * 60%)

25% of W-2 wages and 2.5% of UBIA = $18,750 ((75,000 * 25% * 60%) + (500,000 * 2.5%) * 60%)

The QBID will be $12,000.

REIT and PTP Income

Individuals who receive Real Estate Investment Trust (REIT) or Publicly Traded Partnership (PTP) income can also claim the 20% QBID. The QBID for REITs and PTPs is limited to the lesser of 20% of the QBI or 20% of the taxpayer’s taxable income, less net capital gain. Net capital gain is the sum of capital gains minus capital losses.

Let’s say that your taxable income is $50,000 and you have capital gains of $10,000. Your REIT income for the year is $25,000. Here is how your QBID will be determined:

  1. Calculate Income Limit – $8,000 ($50,000 – $10,000 * 20%)

  1. Calculate QBI – $5,000 ($25,000 * 20%)

Since the QBI of $5,000 is less than the income limit of $8,000, you will be able to take the full QBID. Now let’s say that your net capital gains were $30,000. Your calculation would look like the following:

  1. Calculate Income Limit – $4,000 ($50,000 – $30,000 * 20%)

  1. Calculate QBI – $5,000 ($25,000 * 20%)

In this scenario, your QBID will be limited to $4,000.

Planning and Strategies

Section 199A adds a layer of complexity when tax planning for businesses and individuals. Whether your business is a SSTB or a qualified trade or business, the amount of owner compensation and qualifying property factors into your deduction. When it comes to planning and strategizing, there are three levels to consider: taxable income below the threshold, taxable income above the threshold, and taxable income within the phase-in range.

Taxable Income Below Thresholds

Taxable income below the thresholds will have little trouble in claiming the full QBID, regardless of business structure or type of business. This is because LLC guaranteed payments are treated similarly to s corporation shareholder compensation.

Taxable Income Above the Threshold

Taxable income over the phase-in range leads to no QBID for SSTBs, resulting in no difference between LLCs and s corporations. However, non-SSTBs aren’t subject to income limitations, drawing in the implications of W-2 and UBIA limitations. Guaranteed payments do not count toward the wage limitations, while payments to s corporation owners do. This can make an s corporation structure more favorable if owners receive compensation.

Taxable Income Within the Threshold

Planning for the QBID within the income thresholds as a SSTB is unique to each taxpayer. The timing of income and capital gains will be crucial to maximizing tax savings. Taxpayers with income levels towards the higher end of the phase-in threshold will see a more pronounced impact of the wages and qualified property limitations.

Recent Changes and Updates

Under current provisions is the Tax Cuts and Jobs Act, Section 199A is set to end on December 31, 2025. Although there are talks about extending these provisions, nothing has been solidified as of the time of this writing. The removal of Section 199A will have a serious impact on the tax liability of small business owners and entrepreneurs who utilize QBID to eliminate 20% of income.

In addition, the top tax bracket is set to revert to 39.6% beginning in 2026. This further increases the potential tax bill for small business owners and entrepreneurs. Taxpayers may need to consider making quarterly estimated tax payments and utilizing other tax planning options in light of the expiring Section 199A. Working with an accounting professional is the best way to prepare for these upcoming changes.

Conclusion

The QBID is an important deduction for small business owners and entrepreneurs to lower taxable income. Due to the various limitations, it’s important to work with a qualified accounting firm or invest in accounting services to maximize your deduction.

At KDG, we have a full team of accounting and tax professionals ready to help you navigate the complexities of QBID and the potential impact of changing legislation. Reach out to a team member today to schedule your free consultation.

Additional Resources

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Michele is an accomplished Accountant, bringing a wealth of knowledge and expertise to her current CPA role at KDG. Experienced in Sage Products, Tax Preparation, GAAP, Financial Accounting and Managerial Accounting. Michele has spent her career overseeing tax preparation and accounting services at a multitude of organizations, even owning her own successful CPA firm.

Want to learn more? Book a meeting with us today!

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