199A: Qualified Business Income Deduction

Established in the Tax Cuts and Jobs Act (TCJA) of 2017 under Section 199A, the Qualified Business Income (QBI) deduction allows taxpayers a deduction of up to 20% of income received from a sole proprietorship or pass-through businesses (e.g., partnerships, S corporations, trusts, and estates). You may also hear of it referenced as simply a 199A deduction. The deduction is effective for tax years beginning after December 31, 2017 through 2025. If you are an owner of a sole proprietorship or pass-through entity and considering taking a 199A (QBI) deduction, please engage with a CPA to help ensure it’s done accurately.

What is Qualified Business Income?

Qualified Business Income (QBI) is defined as “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.” Crystal clear, right? Basically, any income (or loss) generated from conducting a trade or business that you would include on your tax return is a qualified item of income. The key phrase here is “conducting a trade or business.” That means capital gains or losses, dividends, and interest are excluded. Relevant to S corporation shareholders, QBI must be reduced by the “reasonable compensation” paid to shareholders, the deductible portion of self-employment tax, self-employed health insurance, and self-employed retirement contributions. Basically, the IRS won’t allow, as part of this deduction, the money you pay yourself through the business and the things you’re already getting a deduction on elsewhere.

Are there limitations?

Of course there are! We’re talking about the tax deductions here. There are two basic limitations: (1) Type of Business and (2) Taxable Income.

Type of Business

Businesses are divided into two categories for the purpose of the QBI deduction: Specified Service Trades or Businesses (SSTBs) and non-SSTBs.

  • SSTBs: Businesses in the fields of health, law, accounting, actuarial science, consulting services, performing arts, athletics, financial services, investment management, trading services, dealing in securities, partnership interests, or commodities, or any business where the principal asset is the reputation or skill of one or more of its employees. These types of businesses are excluded from the deduction UNLESS your taxable income is at or below a particular threshold. Exceptions: Engineering and Architecture business are not considered SSTBs. Lucky you!
  • Non-SSTBs: Anything not identified above.
Taxable Income Thresholds (2022)
  • At or below threshold
    • Single, head of household, qualifying widow(er), trust, or estate: $170,500
    • Married Filing Separately: $170,050
    • Married Filing Jointly: $340,100
  • Within the limitation phase-in range
    • Single, head of household, qualifying widow(er), trust, or estate: $220,050
    • Married Filing Separately: $220,050
    • Married Filing Jointly: $440,100
  • Above the limitation phase-in range
How much can I deduct?

Depends. That’s the answer to every tax question by the way. The answer will depend on your taxable income and the type of business discussed above. Before any limitations, the deduction is the lesser of 20% of QBI or 20% of the excess of taxable income over net capital gains.

  • Taxable income at or below the threshold: When taxable income falls into this category, the type of business does not matter. Both SSTBs and non-SSTBs can claim the deduction. Example: A married taxpayer has $150,000 of QBI, $25,000 of net capital gains, and $40,00 of deductions for a total taxable income of $135,000 ($150K+$25K-$40K). Your 199A (QBI) deduction is the lesser of $30,000 (20% of $150K QBI) or $22,000 (20% of $110K, the excess of of taxable income of $135K over net capital gains of $25K). In this situation, your deduction is $22,000.
  • Taxable income within the limitation phase-in range: This is where the math gets a little bit more…involved. Reductions start flying all over the place. SSTBs must reduce QBI by the percentage they are into the phase-in range before applying the 20% base calculation. Both SSTBs and non-SSTBs must apply a calculation to W-2 wages and the basis of tangible property subject to depreciation (otherwise called Unadjusted Bases Immediately After Acquisition of UBIA) to determine how much excess QBI (if any) over W-2 wages/UBIA is allowable. SSTBs have to reduce the starting number for W-2 wages/UBIA by another percentage before they can calculate if any excess QBI exists. If you truly care about the details of the calculation, buy me a coffee and I’d happily walk you through the details. The better option is to engage with a CPA to help ensure it’s done accurately.
  • Taxable income above the limitation phase-in range threshold: If you’re an SSTB, the answer is easy for you. The deduction is disallowed. “So you get nothing! You lose! Good day sir!” (Name that movie) If you are a non-SSTB, the calculation is somewhat similar to when you are within the phase-in range except you don’t have to go through the process of determining what percentage of excess QBI over W-2 wages/UBIA is allowable. Any excess amount is disallowed. Again, just engage with a CPA to help ensure it’s done accurately.
Conclusion

Long story short, if you are an owner of a sole proprietorship or pass-through entity and considering taking a 199A (QBI) deduction, please engage with a CPA to help ensure it’s done accurately.

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