Taxes are a double-edged story for business owners. On the one hand, they may be subject to a higher tax rate than W-2 employees. On the other hand, business owners may also have more tax-reducing strategies available to them.
One strategy to consider is the Qualified Business Income (QBI) deduction.
Created in 2017 by the Tax Cuts and Jobs Act, the QBI deduction (or 199A deduction) allows certain business owners to reduce their taxable income by up to 20% — if they meet the requirements. Since the QBI deduction is set to be phased out in 2025, it’s worth the time and effort to consider using this strategy as part of an overall tax planning process in the coming years. Doing so could significantly reduce your tax liability.
Important side note before we jump in: C-Corporations are not eligible for this deduction.
Tax Strategy: Qualified Business Income Deduction
The QBI deduction allows pass-through entities (such as sole proprietorships, partnerships, S-Corps, and LLCs) to write off up to 20% of qualified business income.
QBI is defined as the net amount of any income, gains, deductions, and losses from a qualified U.S.-based business. Potential tax advantages extend beyond solely business income: REIT dividends and publicly traded partnership (PTP) income can be included in the total calculation.
Since this can be a powerful tax strategy, the IRS has limited its effect by only allowing businesses to deduct the lesser of:
- 20% of qualified business income + 20% of qualified REIT dividends and qualified publicly traded partnership (PTP) income, or
- 20% of taxable income minus net capital gain.
If your taxable income is under $170,050 (single) or $340,100 (married filing jointly), any type of pass-through entity mentioned above is eligible for the full deduction.
This strategy can get complicated when income exceeds those limits. The IRS implemented a “phase-in” rule which establishes that, as your income rises, your deduction falls. Those with income between $170,050 and $220,050 (single) and $340,100 and $440,100 (joint) will receive a reduced-rate deduction.
If your business is a specialized service trade or business (SSTB) and your income exceeds $220,050 (single) and $440,100 (joint), you cannot claim the deduction. SSTBs include a variety of businesses, but the most common are financial service businesses, law firms, accounting firms, and consulting businesses. If you’re not sure how to classify your business, ask a tax professional.
And remember, even if your income pushes you past the previously mentioned limits, you may still qualify for a partial deduction.
Those who meet the requirements can deduct up to 50% of the W-2 wages paid to employees, or the sum of 25% of W-2 wages plus 2.5% of a qualified property’s unadjusted basis immediately after acquisition.
Advantages:
- Can reduce taxable income by up to 20%
- Can take standard deduction along with QBI
- Certain trusts & estates may qualify for the deduction
Caution:
- Income earned from C-Corporations is not eligible for the deduction
- Certain service-based businesses may be subject to a reduced deduction amount
- Deduction amount is reduced after exceeding defined income levels
Savings Range:
- $3,000 – no fixed cap
Good Business: Section 199A Deduction for Qualified Business Income
As a business owner, few strategies are more powerful than tax strategies. When you reduce taxes, you increase profit. The Qualified Business Income deduction is a good example of a strategy to consider. There are many complexities that come with the strategy, especially for those with higher income, so be sure to work with a trusted tax professional.
And on that note…
If you have recently switched tax preparers (or are thinking about doing that in the near future), be sure to check that the new preparer is including your carryover deduction into the next year’s calculations. It is an easy thing to miss!
Here at TreMonte, we can help you figure out if your business would benefit from incorporating the Qualified Business Deduction. Reach out to a member of our team today!