What Is the QBI Deduction and How Does It Work?
Explore the essentials of the QBI deduction, its eligibility criteria, income types, and calculation process for tax efficiency.
Taxpayers often seek ways to reduce their taxable income, and the Qualified Business Income (QBI) deduction offers a significant opportunity for eligible individuals. Introduced as part of the Tax Cuts and Jobs Act of 2017, this provision allows certain business owners to deduct up to 20% of their qualified business income on their taxes.
Qualifying Businesses
The QBI deduction is available to businesses structured as pass-through entities, such as sole proprietorships, partnerships, S corporations, and certain trusts and estates. These entities transfer income directly to the owners, who report it on their personal tax returns. C corporations, which are taxed separately, do not qualify.
Eligibility also depends on the type of business. Service-based businesses, referred to as specified service trades or businesses (SSTBs), face limitations if their owners exceed specific income thresholds. These include professions like health, law, accounting, and consulting. For 2024, the deduction for SSTBs begins to phase out when taxable income exceeds $364,200 for joint filers and $182,100 for others.
Qualified business income must stem from active business operations. Income like capital gains, dividends, and interest is excluded. Business owners should maintain thorough records to substantiate their claims, as the IRS may scrutinize these deductions.
Types of Income Covered
The QBI deduction applies to income from active business activities. It encompasses the net amount of income, gain, deduction, and loss from a qualified trade or business, excluding investment-related income such as capital gains, dividends, and interest.
Wages earned by employees, even those working for a pass-through entity, are not eligible for the deduction. The provision is specifically designed for business owners rather than employees. Similarly, guaranteed payments to partners and payments to S corporation shareholders for services are excluded.
Rental income may qualify if the activity constitutes a trade or business. This determination depends on the regularity and substantiality of the activity. Actively managing multiple rental properties may qualify, while passive investment generally does not.
Calculating the Deduction
Calculating the QBI deduction involves determining QBI, applying taxable income limits, and performing the final computation.
Determining QBI
To calculate QBI, subtract ordinary business expenses from gross income, excluding non-qualifying income like capital gains and dividends. Adjustments for self-employment taxes, retirement contributions, and health insurance deductions may also apply. For example, if a sole proprietor has $200,000 in gross income and $50,000 in expenses, the QBI is $150,000. Accurate record-keeping is essential.
Applying Taxable Income Limits
The deduction is subject to taxable income limits. For 2024, the threshold is $364,200 for joint filers and $182,100 for others. Taxpayers below these thresholds generally qualify for the full 20% deduction. For those exceeding these limits, the deduction may phase out, particularly for SSTBs. The phase-out range extends to $464,200 for joint filers and $232,100 for others. Careful tax planning can help manage income levels to maximize the deduction.
Final Computation
The final step involves comparing two potential deduction amounts: 20% of QBI and 20% of the excess of taxable income over net capital gains. For example, if a taxpayer has $150,000 in QBI and $200,000 in taxable income with $10,000 in net capital gains, the deduction is the lesser of $30,000 (20% of $150,000) or $38,000 (20% of $190,000). This ensures the deduction does not exceed taxable income. IRS worksheets or tax software can assist in accurate calculations.
Reporting on Tax Forms
Claiming the QBI deduction requires completing IRS Form 8995 or Form 8995-A. Form 8995 is for taxpayers with income below threshold limits, while Form 8995-A applies to more complex cases, including situations involving income above the thresholds or SSTBs subject to phase-outs.
These forms require precise input of QBI, W-2 wages, and the unadjusted basis immediately after acquisition (UBIA) of qualified property. This information is essential for calculating limitations and potential reductions. Figures must align with Schedule C, K-1s, or other relevant forms to avoid errors or audits.