The Qualified Business Income (QBI) deduction, also known as the Section 199A deduction, introduced by the Tax Cuts and Jobs Act (TCJA) in 2017, has been a significant tool for small business owners, including sole proprietors, partnerships, S corporations, and some trusts and estates.

As we look towards 2024 and beyond, it's crucial for small business owners to grasp the nuances of this deduction to maximize their tax benefits. This blog post aims to provide a comprehensive overview of the QBI deduction, its eligibility criteria, calculation methods, and strategic considerations for future planning.

1. Eligibility for the QBI Deduction

The QBI deduction allows eligible business owners to deduct up to 20% of their qualified business income from their taxable income. It's important to note that the deduction is available only to non-corporate taxpayers, meaning income earned through a C corporation does not qualify. Eligible entitles include: Sole Proprietorships, Partnerships, S Corporations, Trusts, and Estates.

The QBI deduction primarily applies to the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. This includes:

• Business Income: Profits earned from a trade or business that are reported on your tax returns.
• REIT Dividends: Dividends from Real Estate Investment Trusts that are not qualified dividend income.
• PTP Income: Income from Publicly Traded Partnerships.

Exclusions from QBI:

• Investment-related items such as capital gains or losses, dividends, and interest income not connected to the business.
• Wage income or guaranteed payments received for services rendered to a partnership.
• Income earned outside of the United States.
• Income from C corporations.

2. Calculating the Deduction

The QBI deduction calculation can be straightforward but varies based on the taxpayer’s total taxable income. The deduction is generally 20% of your QBI from a qualified trade or business. However, several limitations may apply based on the type of business, the taxpayer's taxable income, and whether the business pays W-2 wages or holds qualified property.

Phase-out and Limitations:

• Income Thresholds: The full deduction is available to those with taxable income below $191,950 for single filers or 383,900 for joint filers in 2024. Above these thresholds, limitations based on W-2 wages and UBIA of qualified property begin to phase in.
  • Greater of:
    
    • 50% of W2 Wages, or
    • 25% of W2 Wages + 2.5% of UBIA (Basis in Qualified Property)
• Specified Service Trades or Businesses (SSTBs): Businesses in fields like healthcare, law, financial services, athletics, performing arts, accounting, and consulting face additional limitations. If your income is above the threshold, the deduction for SSTBs begins to phase out.
  • It completely phases out at $241,950 for single filers or $483,900 for joint filers in 2024.

Calculation Steps:

• Step 1: Determine Your Total QBI from Each Qualified Business
• Step 2: Determine Threshold and Phase-In/Phase Out Rules (If Applicable)
• Step 3: Calculate the Deduction

3. Example Deduction

Lets go through an example. Here are some facts:

• Net Business Income: $100,000
• W-2 Wages Paid: $30,000
• UBIA (Basis in Qualified Property): $50,000

Scenario 1: Taxable Income Below the Threshold

You simply calculate the deduction at 20% of the the net business income which would be a $20,000 QBI deduction.

 Scenario 2: Taxable Income Above the Threshold for Non SSTB

• Determine Limitations
  • 50% of W2 Wages: $30,000 x 50% = $15,000
  • 25% of W2 Wages + 2.5% of UBIA: ($30,000 x 25%) + (2.5% x $50,000) = $8,750
  • Choose Greater = $15,000
• QBI Deduction = Lessor of Regular QBI Deduction or Limitation Deduction
  • In this example, the QBI Deduction would be $15,000

Once you start to hit certain income limitations and mix in different business types (SSTB or non-SSTB) the calculation can start to get complicated.  We do not want to go through all of those details in this blog but just know that your accountant can help determine this.

4. Strategic Tax Planning for 2024 and Beyond

Looking forward, small business owners should consider several strategies to maximize their QBI deduction:

• Business Structure: Evaluate whether your current business structure is the most beneficial for tax purposes.
• Wage Considerations: Consider the potential benefits of increasing W-2 wages to maximize the QBI deduction, especially if your business is close to the threshold where limitations kick in.
• Investment in Property: Acquiring new business property could increase your UBIA, potentially increasing your QBI deduction.
• Income Level Management: For those near the threshold where the SSTB limitations impact the deduction, consider strategies to manage your income levels effectively. This could involve things like charitable contributions planning, etc.

5. Claiming the Deduction

This deduction is related to business income but the actual deduction is taken on your individual/personal tax return (Form 1040).

• Form 8995 on Your Personal Tax Return (Form 1040): This form is used by individuals, estates, and trusts with QBI, qualified REIT dividends, or qualified PTP income to calculate the QBI deduction if their taxable income before the QBI deduction is below the threshold. It provides a simplified method for calculating the deduction.
• Form 8995-A on Your Personal Tax Return (Form 1040): This form is required for taxpayers with taxable income above the threshold amounts, those with multiple businesses, or those who need to apply more complex rules such as those for specified service trades or businesses or for calculating W-2 wage and property limitations.
• Form 1040 (Personal Tax Return): While not specific to the QBI deduction, the total QBI deduction calculated on Form 8995 or Form 8995-A is reported on Form 1040, which is the standard form used by individuals to file their annual income tax returns.
• Form K-1 (Form 1065, Form 1120S, Form 1041): This form is not used to calculate the QBI deduction but is essential for pass-through entities (like partnerships, S corporations, and some trusts and estates) to report each shareholder's, partner's, or beneficiary's share of the business's income, deductions, and credits. It provides the necessary information to the taxpayer about their share of the business income, which is needed to calculate the QBI deduction, which is done on the personal side.

6. Future Considerations

The QBI deduction is currently set to expire after 2025 unless extended by Congress. Small business owners should stay informed about legislative changes that could impact this deduction and plan accordingly.

Conclusion

The QBI deduction represents a significant tax-saving opportunity for small business owners. By understanding the eligibility requirements, calculation nuances, and strategic planning options, you can effectively leverage this deduction to minimize your tax liability and enhance your business's financial health. As always, consult with a tax professional to tailor these strategies to your specific circumstances and stay updated on any changes to tax laws.