If you are a self-employed or small business owner, you may be eligible for a tax deduction that can save you thousands of dollars on your income tax bill. This deduction is called the qualified business income (QBI) deduction, and it allows you to deduct up to 20% of your net income from your business activities.
The QBI deduction was created by the Tax Cuts and Jobs Act of 2017, and it is available for tax years 2018 to 2025. The purpose of this deduction is to provide a tax break for pass-through entities, such as sole proprietorships, partnerships, S corporations, and some trusts and estates. These entities do not pay corporate income tax, but rather pass their income and losses to their owners, who report them on their personal tax returns.
The QBI deduction is not available for C corporations, which pay their own corporate income tax, or for employees, who receive wages or salaries from their employers. However, if you have income from both a pass-through entity and a C corporation or an employer, you may still qualify for the QBI deduction on the portion of your income that comes from the pass-through entity.
How to Calculate the Qualified Business Income Deduction
The QBI deduction is equal to the lesser of:
- 20% of your QBI from your pass-through entity, plus 20% of your qualified REIT dividends and qualified publicly traded partnership (PTP) income, or
- 20% of your taxable income minus your net capital gain.
QBI is the net amount of income, gain, deduction, and loss from your qualified trade or business, which is any business activity that you conduct in the United States, except for certain specified service trades or businesses (SSTBs), such as health, law, accounting, consulting, financial services, and others. QBI does not include investment income, such as interest, dividends, or capital gains, or wage income, such as salaries or bonuses.
Qualified REIT dividends are dividends from real estate investment trusts (REITs) that are not capital gain dividends or qualified dividend income. Qualified PTP income is income from publicly traded partnerships (PTPs) that are not SSTBs.
The QBI deduction is subject to limitations, depending on your taxable income and the type of your business. If your taxable income is below a certain threshold ($164,900 for single filers and $329,800 for married filing jointly in 2021), you can claim the full 20% deduction, regardless of the type of your business. However, if your taxable income is above the threshold, your deduction may be reduced or eliminated, depending on the following factors:
- Whether your business is an SSTB or not. If your business is an SSTB, your deduction will be phased out completely once your taxable income reaches $214,900 for single filers and $429,800 for married filing jointly in 2021. If your business is not an SSTB, you can still claim the deduction, but it will be subject to the next two factors.
- The amount of W-2 wages paid by your business. Your deduction cannot exceed 50% of the W-2 wages paid by your business to its employees. W-2 wages are the total wages subject to federal income tax withholding, plus the elective deferrals and deferred compensation paid by your business to its employees. If your business does not have any employees, you will not be able to claim the deduction, unless you qualify for the next factor.
- The unadjusted basis immediately after acquisition (UBIA) of qualified property held by your business. Your deduction cannot exceed 25% of the W-2 wages paid by your business, plus 2.5% of the UBIA of qualified property held by your business. Qualified property is any tangible property that is used in your business, subject to depreciation, and has a depreciable period of at least 10 years. UBIA is the original cost of the property, without any adjustments for depreciation or other factors.
To calculate your QBI deduction, you need to determine your QBI, your qualified REIT dividends, your qualified PTP income, your taxable income, your net capital gain, your W-2 wages, and your UBIA of qualified property for each of your pass-through entities. You can use Form 8995 or Form 8995-A to compute your deduction, depending on the complexity of your situation. You can also use online calculators or tax software to help you with the calculation.
How to Claim the Qualified Business Income Deduction
The QBI deduction is a below-the-line deduction, which means that it reduces your taxable income, but not your adjusted gross income (AGI). You can claim the QBI deduction whether you itemize your deductions or take the standard deduction. You do not need to attach any additional forms or schedules to your tax return, unless you are required to file Form 8995 or Form 8995-A. You simply enter the amount of your QBI deduction on line 13 of Form 1040 or Form 1040-SR.
The QBI deduction is a valuable tax benefit for self-employed and small business owners, but it can also be complicated and confusing. If you are not sure how to calculate or claim the QBI deduction, you may want to consult a professional tax preparer or advisor, who can help you maximize your tax savings and avoid any errors or penalties.
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Robert Hall & Associates can help you:
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