Since the qualified business income (QBI) deduction first become available in 2018, things have changed dramatically, mainly due to the various effects of the COVID-19 pandemic. Possible tax rate increases and inflation have also entered into the mix. How do these developments affect planning to maximize QBI deductions for your business?
What’s an SSTB? In general, a specified service trade or business (SSTB) means any trade or business involving the performance of services in one or more of the following fields:
Before the IRS issued regulations, there was concern that the last item on this list could snare unsuspecting businesses, including local restaurants with well-known chefs. Thankfully, the regulations limit the last definition to trades or businesses that receives fees, compensation, or other income for:
|
The basics
The QBI deduction was one of the cornerstones of the Tax Cuts and Jobs Act. For 2018 through 2025, the deduction is available to eligible individuals, trusts and estates, but it’s not available to C corporations or their shareholders.
The QBI deduction can be up to 20% of:
QBI earned from a sole proprietorship or single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
QBI from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes or an S corporation.
Pass-through business entities report their tax items to their owners who then take them into account on their owner-level returns. The QBI deduction, when allowed, is then written off at the owner level.
Important: This article focuses on individual taxpayers who can claim QBI deductions, with the understanding that essentially the same considerations apply to trusts and estates.
Close-up on QBI
QBI means qualified income and gains from an eligible business reduced by related deductions and losses. QBI from a business is reduced by allocable deductions for:
Contributions to a self-employed retirement plan,
Part of your self-employment tax bill, and
Self-employed health insurance premiums.
The following items do not count as QBI:
Income from the business of being an employee,
Guaranteed payments received by a partner or an LLC member treated as a partner for tax purposes for services rendered to the business,
Salary collected by an S corporation shareholder-employee, and
Salary collected by a C corporation shareholder-employee.
On your personal return, the QBI deduction doesn’t reduce your adjusted gross income (AGI). In effect, it’s treated the same as an allowable itemized deduction.
Unfortunately, the QBI deduction doesn’t reduce your net earnings from self-employment for purposes of the self-employment tax nor does it reduce your net investment income for purposes of the 3.8% net investment income tax (NIIT) on higher-income taxpayers.
Limitations
At higher income levels, unfavorable QBI deduction limitations may come into play. These income limits are indexed annually for inflation. Here are the income-based phase-in thresholds for 2020 through 2022:
Phase-In Ranges for 2020 through 2022
Filing Status | 2020 | 2021 | 2022 |
Married Filing Jointly | $326,600 – $426,600 | $329,800 – $429,800 | $340,100 – $440,100 |
All Others | $163,300 – $213,300 | $164,900 – $214,900 | $170,050 – $220,050 |
These limitations are phased in over a taxable income range of $50,000, or $100,000 for married couples who file joint returns.
If you exceed the applicable fully phased-in threshold, your QBI deduction is limited to the greater of:
Your share of 50% of W-2 wages paid to employees during the tax year and properly allocable to QBI, or
The sum of your share of 25% of such W-2 wages plus your share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.
The limitation based on the UBIA of qualified property is for the benefit of capital-intensive businesses, such as manufacturing or hotel operations. Qualified property means depreciable tangible property (including real estate) that meets the three criteria:
It’s owned by a qualified business as of its tax year end,
It’s used by that business at any point during the tax year for the production of QBI, and
It hadn’t reached the end of its depreciable life as of the tax year end.
The UBIA of qualified property generally equals its original cost when it was first put to use in your business.
Finally, your QBI deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and before any net capital gain (net long-term capital gains in excess of net short-term capital losses plus qualified dividends).
Unfavorable rules for SSTBs
If your operation is a specified service trade or business (SSTB), QBI deductions begin to be phased out when your taxable income (calculated before any QBI deduction) exceeds the applicable threshold. See “What’s a SSTB?” above.
The following phase-out ranges apply to SSTBs for 2020 through 2022:
Phase-Out Ranges for 2020 through 2022
Filing Status | 2020 | 2021 | 2022 |
Married Filing Jointly | $326,600 – $426,600 | $329,800 – $429,800 | $340,100 – $440,100 |
All Others | $163,300 – $213,300 | $164,900 – $214,900 | $170,050 – $220,050 |