How Do I Claim the Qualified Business Income Deduction?

The Qualified Business Income (QBI) Deduction is a tax benefit introduced by the Tax Cuts and Jobs Act of 2017. It allows eligible taxpayers to deduct up to 20% of their qualified business income, reducing taxable income. Understanding this deduction is crucial for maximizing its benefits.

This article explains eligibility, calculation methods, and reporting requirements for the QBI Deduction.

Eligible Business Entities

The QBI Deduction is available to pass-through entities such as S corporations, partnerships, and LLCs taxed as partnerships. These businesses do not pay corporate income tax; instead, their income is passed to the owners, who report it on personal tax returns. This structure enables individual taxpayers to benefit directly by reducing their taxable income.

Sole proprietorships also qualify. As the simplest business structure, sole proprietors report income on Schedule C of their personal tax return. The deduction can significantly reduce net taxable income, providing meaningful tax savings.

Real Estate Investment Trusts (REITs) and publicly traded partnerships (PTPs) are treated differently. While these entities are not pass-through entities, income from REIT dividends and PTPs can be included in the QBI calculation. This inclusion allows investors to benefit from the deduction.

Key Income Thresholds

Income thresholds play a critical role in determining eligibility for the QBI Deduction. For the 2024 tax year, the thresholds are $364,200 for married couples filing jointly and $182,100 for single filers. Taxpayers within these thresholds can claim the full 20% deduction without additional limitations.

For taxpayers exceeding these thresholds, the deduction becomes more complex. Factors like business type and total taxable income influence eligibility. For specified service trades or businesses (SSTBs), such as law, health, and consulting, the deduction phases out once income surpasses the threshold and is eliminated at $464,200 for joint filers and $232,100 for single filers in 2024.

Components of QBI

The QBI Deduction is derived from several components, each contributing to the final calculation.

Pass-Through Income

Pass-through income is central to the QBI Deduction and originates from entities like S corporations, partnerships, and LLCs. This income is reported on personal tax returns, typically on Schedule E. Capital gains, dividends, and interest income are excluded from QBI. Taxpayers must separate qualifying income from non-qualifying income to calculate the deduction accurately. Limitations based on W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property may also apply.

Sole Proprietorship Income

For sole proprietors, the deduction is based on net income reported on Schedule C. The business must meet the criteria under the Internal Revenue Code (IRC) Section 162, requiring activities to be regular, continuous, and substantial. The deduction equals 20% of net income, subject to the same income thresholds and limitations as other entities. Accurate record-keeping of income and expenses is essential for substantiating claims.

REIT Dividends

REIT dividends are a unique aspect of the QBI Deduction. While REITs are not pass-through entities, qualified REIT dividends can be included in the deduction calculation. These dividends are eligible for a 20% deduction regardless of income level, making REIT investments attractive for tax planning. Taxpayers must report these dividends on Form 8995 or Form 8995-A. Only qualified REIT dividends, not other dividend types, are eligible for the deduction.

Calculation Method

Calculating the QBI Deduction requires attention to detail and adherence to tax regulations. Taxpayers can deduct up to 20% of their qualified business income, but limitations apply. The deduction is the lesser of 20% of QBI or 20% of taxable income minus net capital gains.

Taxpayers must first determine their QBI, excluding income such as capital gains, dividends, and interest. After applying the 20% deduction to QBI, additional limitations may apply, including W-2 wage limitations and UBIA of qualified property for certain businesses. Understanding these rules is essential for accurate calculations.

Reporting on Federal Returns

Claiming the QBI Deduction requires proper reporting on federal tax returns. Taxpayers must calculate the deduction and report it on either Form 8995 or Form 8995-A, depending on their income and other factors.

Form 8995 is used by taxpayers with income below the threshold, where no additional limitations such as W-2 wages or SSTB considerations apply. This simplified form focuses on calculating the 20% deduction based on QBI, taxable income, and qualified REIT dividends or PTP income.

For taxpayers with income above the threshold or those with additional limitations, Form 8995-A provides a detailed framework. This form includes schedules for W-2 wage limitations, UBIA of qualified property, and SSTB phase-outs. Completing these schedules accurately is crucial. Using professional tax advice or reliable tax software can simplify the process.

Handling Multiple QBI Sources

Taxpayers with income from multiple qualified businesses face additional challenges. Each business must be evaluated separately to determine its QBI, which is then aggregated to calculate the total deduction.

Profitable and loss-generating businesses must be netted against each other. For instance, if one business earns $100,000 in QBI and another incurs a $30,000 loss, the net QBI is $70,000. If losses exceed profits, the net loss carries forward to future years, reducing future QBI Deductions.

Taxpayers with income from various entities, such as sole proprietorships and S corporations, must follow specific rules for each type. For example, W-2 wage limitations apply to S corporations but not to sole proprietorships. REIT dividends and PTP income are treated separately and not aggregated with other QBI sources. Proper documentation and professional advice are essential for managing these complexities.