A large part of the U.S. population has likely read about the Tax Cuts and Jobs Act passed on December 22, 2017. Many that have done their exciting reading (sense the sarcasm) have been introduced to the qualified business income deduction (QBID), a deduction that comes across as confusing and difficult to calculate. This brief article attempts to breakdown the barriers that prevent a thorough understanding of the QBID.
First, let’s understand who can take this deduction. The QBID was created so that sole proprietors, partners of partnerships, and shareholders of S-corporations could qualify for a potentially significant deduction based on qualified business income. Please note that corporations, aside from S-corporations, do not qualify for the QBID.
Qualified business income generally includes net income from operating a qualified trade or business. We like to use the word generally as, like most tax law, there are exceptions to the eligibility for a deduction. Investment income items are one exception. This includes capital gains, most dividend income, investment interest income, annuity income, and other less common forms of investment income. Another exception is reasonable compensation paid to a taxpayer by a qualified trade or business that the taxpayer owns for services rendered to such trade or business. This includes guaranteed payments paid to a partner for services such partner rendered to his/her partnership.
A qualified trade or business for purposes of taking the QBID does not generally include any specified trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. However, if for any tax year, the taxable income of any taxpayer is less than $157,500 ($315,000 MFJ), the exclusion for a specified trade or business does not apply. A phaseout threshold applies to taxpayers that receive more than the amounts above. Upon reaching $207,500 ($415,000 MFJ) of taxable income, no deduction is allowed for such taxpayer.
Upon a taxpayer reaching $157,500 ($315,000 MFJ) of taxable income, the QBID is limited to the lesser of:
20% of the taxpayer’s qualified business income or
The greater of 50% of the W-2 wages relating to the qualified trade or business or the sum of 25% of the W-2 wages relating to such trade or business and 2.5% of the unadjusted basis immediately after acquisition of all qualified property
This limitation does not apply to a taxpayer in a specified trade or business. Taxable income attributable to such specified trade or business is subject to the phase-out rule above.
Taxpayers that think they qualify for the QBID should contact their CPA soon to ensure they can take full advantage of this new deduction for 2018 and future years.