Overview of Qualified Business Income Deduction
The Tax Cuts and Jobs Act adds a new deduction for noncorporate taxpayers for qualified business income (QBI). The deduction is also referred to as the “pass-through deduction.” It should provide a substantial benefit to individuals with QBI. The deduction reduces taxable income, rather than adjusted gross income, but is available to taxpayers regardless of whether they itemize or take the standard deduction. In general, the deduction cannot exceed 20% of the excess of the taxpayer’s taxable income over net capital gain.
The deduction is generally 20% of a taxpayer’s QBI from a partnership, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to the trade or business. Certain types of investment-related items are excluded from QBI, e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). Employee compensation and guaranteed payments to a partner are also excluded.
The deduction for taxpayers in service businesses is phased out if the taxpayer’s taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return). Service businesses include; healthcare professionals, law, accounting, actuarial science, performing artists, consulting, athletics, financial services, brokerage services (investing and investment management, trading, or dealing in securities, partnership interests, or commodities), and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
Taxpayers in non-service related businesses whose taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return) are also subject to limitations based on the W-2 wages and the adjusted basis in acquired qualified property.
The deduction is taken for partnerships and S corporations at the individual partner or shareholder level. Trusts and estates are also eligible for the deduction. W-2 wages and the adjusted basis in acquired qualified property are apportioned between the trust or estate and the beneficiaries. Specified agricultural or horticultural cooperatives are also eligible for the deduction under special rules.
Qualified business income includes only income effectively connected with a U.S. trade or business. However, qualified business income from sources within Puerto Rico is eligible for the deduction if all the income is subject to tax in the U.S.
The deduction is effective for tax years beginning Jan. 1, 2018 and does not apply to tax years beginning after Dec. 31, 2025.
Obviously, the complexities surrounding this substantial new deduction are many, especially if your taxable income exceeds the thresholds discussed above.
If you would like to discuss how the mechanics of the deduction may impact you or would like additional information, please give us a call.
Jeff Benson, CPA
Copeland Buhl & Company PLLP