The Tax Cuts and Jobs Act (TCJA) of 2017 enacted the IRC Sec. 199A qualified business income (QBI) deduction. The QBI deduction allows a deduction of up to 20% of qualified business income for eligible flow-through entities. The deduction is available to all taxpayers other than regular C Corps. The QBI deduction is taken from AGI.
What is qualified business income?
QBI is ordinary, trade & business income minus ordinary deductions earned by flow-through entities (sole proprietorship, S Corp, LLC, or partnerships). Compensation (wages, guaranteed payments, etc.) and separately stated items (dividends, interest, capital gains) are not includable in QBI.
What flow-through entities are eligible?
Sec. 199A classifies two types of eligible flow-through entities: Qualified Trade or Business (QTB) and Specified Service Trade or Business (SSTB). The IRC defines QTB as any other business other than a SSTB (real helpful!). Examples of QTB include engineering businesses and architectural business. The IRC states that a SSTB is a trade or business in the fields of health, accounting, law, performing arts, consulting, investing, and athletics. It goes further stating that the SSTB category includes trades dependent upon reputation and skill. QTBs and SSTBs face different limitations relating to the deduction.
How to calculate the QBI deduction?
20% x QBI = QBI deduction
The taxpayer’s taxable income and the category of business (QTB vs. SSTB) create limitations. The limitations will reduce or eliminate the deduction.
Taxable Income Limitation
*the taxable income amounts are subject to inflation changes
The taxable income limitation creates three types of taxpayers.
- Taxpayers with taxable income at or below $160,700 (S)/$321,400 (MFJ)
- Taxpayers with taxable income between $160,700 and $210,700 (S)/$321,400 and $421,400 (MFJ)
- Taxpayers with taxable income above $210,700 (S)/$421,400 (MFJ)
Remember that these amounts are subject to change. They reflect the current 2019 amounts.
W-2 wage and property limitation
The taxpayer’s taxable income triggers the W-2 wage and property limitation. When applicable to the taxpayer, the W-2 wage and property limitation limits the QBI deduction to the greater of:
- 50% of W-2 wages for the business entity; or
- 25% of the W-2 wages + 2.5% of the unadjusted basis of all qualified property.
Overall Taxable Income Limitation
Sec. 199A also places an overall taxable income limitation on the QBI deduction. The overall taxable income limitation states that the QBI deduction is the lesser of:
- QBI deduction; or
- 20% of the taxpayer’s taxable income in excess of net capital gains
Taxpayer Category and Limitation Application
Type 1 [Taxpayers with taxable income at or below $160,700 (S)/$321,400 (MFJ)]
- If QTB, then Full 20% QBI deduction
- If SSTB, then Full 20% QBI deduction
Basically, if the taxpayer is below the threshold, then no limitations and restrictions apply to the QBI deduction.
Type 2 [Taxpayers with taxable income between $160,700 - $210,700 (S)/$321,400 - $421,400 (MFJ)]
- If QTB, then phase-in the W-2 wage and property limitation
- If SSTB, then QBI, W-2 wages, and qualified property amounts are reduced, followed by the phased-in W-2 wage and property limitation reduction
Due to the complexity of the Type 2 SSTB category, please see the separate post explaining the category and providing a helpful example! Link HERE!
Type 3 [Taxpayers with taxable income above $210,700 (S)/$421,400 (MFJ)]
- If QTB, then full W-2 wage and property limitation reduction applies
- If SSTB, then no QBI deduction allowed
For any questions or concern relating to the QBI deduction and how to calculate it in 2019, please comment below.