What Is a Qualified Domestic Corporation (QDC)?
A Qualified Domestic Corporation has a special tax status that allows its shareholders in Puerto Rico to claim the U.S. Qualified Business Income deduction.
The Qualified Business Income (QBI) deduction, from Section 199A of the Internal Revenue Code, offers a tax benefit to owners of certain domestic businesses. The provision includes special considerations that extend its benefits to income from a trade or business in Puerto Rico for its bona fide residents.
This allows owners of pass-through businesses, such as sole proprietorships, partnerships, and S corporations, to deduct up to 20% of their qualified business income. The rules treat Puerto Rico as part of the United States for this deduction, impacting the U.S. tax liability of business owners who are residents of the island. Income from a C corporation is not eligible for the QBI deduction.
Business Income from Puerto Rico and the QBI Deduction
For business income from Puerto Rico to be eligible for the QBI deduction, it must be from a qualified trade or business. The income must be from a business actively conducted within Puerto Rico for the entire taxable year, which requires regular, continuous, and substantial operations on the island, not merely passive investment.
For a bona fide resident of Puerto Rico, their Puerto Rico-sourced business income is treated as eligible for the QBI deduction. This rule ensures the tax benefit is tied to economic activity genuinely connected to Puerto Rico. The Section 199A deduction is scheduled to expire for taxable years beginning after December 31, 2025, unless extended by new legislation.
Tax Treatment for Business Owners
The benefit of these rules flows to the owners of pass-through businesses who are bona fide residents of Puerto Rico. These individuals can include their share of income from a qualifying Puerto Rican business in their Qualified Business Income (QBI) calculation for the Section 199A deduction.
This special rule extends a U.S. tax benefit to income generated within Puerto Rico. For a bona fide resident of Puerto Rico, qualifying income from the business can lower their overall U.S. tax liability. This provision acknowledges the unique economic relationship between the U.S. and Puerto Rico.
The QBI deduction is calculated at the individual owner’s level and is subject to limitations. The deduction cannot exceed 20% of the taxpayer’s taxable income before the deduction, computed without regard to net capital gains. The owner’s overall income situation directly impacts the final amount of the deduction.
Information Needed for the QBI Calculation
To calculate the QBI deduction, a business owner must have specific data from their pass-through entity. The primary information is the owner’s allocable share of the business’s Qualified Business Income (QBI), which represents the net amount of qualified items of income, gain, deduction, and loss from the business. The business is responsible for determining this figure and providing it to each owner, often through a Schedule K-1.
The calculation may also be limited by two other factors that must be provided by the business: the owner’s share of W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property. Qualified property generally includes tangible, depreciable property used in the trade or business.
These two figures—W-2 wages and UBIA of qualified property—become relevant if the owner’s personal taxable income exceeds certain thresholds. For higher-income taxpayers, the QBI deduction is limited to the greater of 50% of their share of the W-2 wages or 25% of their share of W-2 wages plus 2.5% of their share of the UBIA of qualified property. Gathering this complete data package from the business is necessary for any owner to claim the deduction.
Reporting Business Income for the QBI Deduction
Once a business owner has the necessary information, the Qualified Business Income deduction is calculated and claimed on their U.S. individual income tax return. The primary form for this calculation is Form 8995, Qualified Business Income Deduction Simplified Computation, or Form 8995-A for those with taxable income above the statutory thresholds.
On the appropriate form, the owner enters the specific data received from their business. The forms have dedicated lines to input the QBI, the allocable share of W-2 wages, and the share of the UBIA of qualified property. The form then guides the taxpayer through the calculation, applying the relevant limitations.
The resulting deduction amount is carried to the appropriate line on Form 1040 or Form 1040-NR. This deduction directly reduces the owner’s taxable income, not their gross income, resulting in a lower overall tax bill.