Qualified business income deduction: Keys to claiming this big tax break

For certain small business owners, the qualified business income deduction (QBID) was one of the major elements of 2017’s Tax Cut and Jobs Act (TCJA). The rule allows business owners to take up to a 20% deduction of their profits if they qualify. If you’re new to business taxes or to the QBID, you won’t want to miss out on this valuable tax benefit. Learn all about what the qualified business income deduction is, how it works and can benefit you, and how to claim it in this post.

What is a qualified business income deduction?

First, let’s outline what this tax term means for you – “so, what is a qualified business income deduction?” Long story short, it’s a valuable tax-saving deduction that is somewhat new to the scene after TCJA introduced it in 2017.

Essentially, the qualified business income deduction offers tax reprieve by providing an individual deduction of up to 20% of a business’s qualified business income.

Section 199A

The qualified business income deduction (QBID) is also known as the Section 199A deduction because the rule comes from Section 199A of the Internal Revenue Code.  The QBID is also known as the pass-through deduction, QBI deduction, and the 20% deduction.

What is qualified business income?

Now, let’s answer “what is qualified business income?” because, to be frank, not all business income qualifies. Qualified business income includes:

• Qualified items of business income, gain, deduction, and loss from the sale of goods or services allowed in calculating taxable income for the year,
• Income effectively connected with running a trade or business in the United States,
• Income from partnerships (other than publicly traded partnerships), S corporations, sole proprietorships, and certain estates and trusts.

A separate component of the qualified business income deduction covers:

• Qualified publicly traded partnership income
• Qualified real estate investment trust dividends (known as Section 199A dividends)

Who can claim the qualified business income deduction?

The qualified business income deduction is available to eligible small business-owning taxpayers, whether the business owners itemize deductions or take a standard deduction.

Yet, QBID may be limited depending on your type of business. The qualified business income deduction applies to any business operated as a sole proprietorship, partnership, or S Corporation. (C Corporations are not eligible for the deduction.)

Additionally, an individual taxpayer without qualified business income can’t claim it.

Section 199A limitations

There are a few limits to who can take Section 199A deductions – and how they’re taken. They are as follows:

1. Type of trade or business – Certain service businesses can face steep phaseouts if 2020 taxable income before the QBI deduction exceeds $163,300 (single, Married Filing Separately, Head of Household, or Qualified Widower) or $326,600 (Married Filing Jointly).
2. 20% taxable income limit – The deduction can’t exceed 20% of taxable income minus net capital gain.
3. Wage and property limit – If your yearly taxable income exceeds $326,600 for a married couple filing a joint return, or $163,300 for all other taxpayers, QBID may be partially or fully reduced to the greater of 50% of W-2 wages paid by the business and or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified depreciable business assets.

Sound complex? Don’t worry; you don’t have to go it alone. That’s why we’re here.  You can always get help from a  Block Advisors small business certified tax pro .

How much is the qualified business income deduction?

The QBI deduction is generally equal to the lesser of these two amounts:

• 20% of qualified business income plus 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income
• 20% of taxable income computed before the qualified business income deduction minus net capital gain

QBI deduction put into practice

Still confused about the benefits of the QBI deduction? Let’s review an example:

A small business owner with qualified net business income of $80,000 (and no other income) can deduct the lesser of:

20% of net business income

-OR-

20% of taxable income

If they use the Single filing status and their taxable income is $73,880, the QBI deduction may be $14,776.

If they claim the standard deduction of $12,400 (2020), the small business owner can deduct both the QBI deduction of $14,776 plus the standard deduction of $12,400.

As a result, they will pay tax on $52,824 ($80,000 – $14,776 – $12,400 = $52,824).

When can you claim the QBI deduction?

As a small business owner, you can’t automatically get the Section 199A deduction – a little extra paperwork is necessary. You should claim the QBI deduction on your federal income tax return on Form 1040 via Form 8995 or Form 8995-A. Luckily, we can help. Our Block Advisors small business tax pros speak the tricky language of taxes.

Help with the QBID and other small business tax concerns

If you want hands-on tax guidance, let us help. With more than a million small business clients, our tax pros can help you prepare a Schedule C and claim the qualified business income deduction– and optimize your small business’ tax outcome. In addition, we provide bookkeeping and payroll services, to help you  get back to running the business you love.

Make an appointment.