Understanding the New Qualified Business Income Deduction
After the reduction of corporate tax rate from a high of 35% to a flat rate of 21%, the Tax Cut and Jobs Act (TCJA) added a new qualified business income deduction for for all businesses that aren’t C corp. The QBI essentially offers a potential deduction of up to 20% of pass-through income, basically taxpayers who qualify would end up paying taxes on 80% of the income that flows through to them. By definition, the QBI (or qualified business income) is the amount of income, gain, deduction and loss in respect with trade or business, so investment income such as capital gains, dividends and interest income, gains from foreign exchange transactions are specifically not included. The basic rule for the deduction is the lesser of: - 20% of qualified business income Or -20% of taxable income in excess of net capital gains
We have to keep in mind also that there’s a phaseout range of $315,000 to $415,000 for married taxpayers (or $157,500 to $207,500 for single taxpayers) where calculations for the deduction above that range get a bit more complex, and also dependent on the type of business income which is categorized in two buckets: - A specified service business (SSB): which includes businesses performing services in the areas of health, law, accounting, consulting, financial services, performing arts, or any other business that heavily depend on the skill of their employees ( engineering and architecture were specifically excluded from that list). -Other businesses. Calculations for amounts within the phaseout range is where it gets complex: - For businesses that are NOT a specified service business (SSB) the deduction is reduced by a pro-rata portion of the excess of (1) over (2): (1) 20% of Qualified business income (2) The GREATER of: - 50% of the taxpayer allocable share of the W-2 wages Or
-25% of the taxpayer allocable share of the W-2 wages, plus 2.5% allocable share of the unadjusted basis of qualified property.
-For Specified service businesses (SSB): qualified business income, wages, and qualified property are all reduced by: 1- percentage above the threshold, then calculated in the same manner as a non specified service business.
Calculations for amounts over the threshold: -For businesses that are NOT a specified service business the deduction equals the LESSER of: (a) 20% of Qualified Business Income (b) the GREATER of: - 50% of the taxpayers allocable share of the W-2 wages
- 25% of all taxpayer allocable share of the W-2 wages, plus 2.5% allocable share of the unadjusted basis of the qualified property.
-For Specified Service Businesses: NO deduction allowed. Disclaimer: This material has been prepared without regard to a specific situation and as such, material in this article is for educational purposes only and shouldn’t be taken as advice. AG Wealth Management does not provide tax preparation services, please consult with your own CPA before taking any action.