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Qualified Business Income Deduction

Starting in 2018, the Tax Cuts and Jobs Act entitles owners of sole proprietorships (who file via Schedule C or E), partnerships, LLCs, and S Corporations to take a deduction equal to 20% of the "qualified business income" earned from the business. "Qualified business income" – QBI for short – can be defined as the operating income of the business (operating revenue - business expenses). QBI does not include capital gains, interest, or dividend income. Any business owner with taxable income less than $315,000 or $157,500 (married/single) in 2018 can take the full 20% deduction against their QBI. Limitations to the deduction start to apply once taxable income exceeds these amounts. Above $415,000/$207,500 (married/single), business owners can only take the lesser of: -20% of qualified business income, or -50% of the total W-2 wages paid by the business. Additionally, the TCJA excludes certain business types from taking the QBI deduction when they surpass the income thresholds above. In general terms, any business with income above the threshold and involved in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services is defined as a "specified service business" disallowed from taking the deduction. Furthermore, the law also excludes businesses "where the principal asset of such trade or business is the reputation or skill of one or more of its employees [or owners].”

DRIVER / RIDESHARE

Mary, a single entrepreneur, drives for Lyft, Uber, and Amazon Flex in the Bay Area. Her qualified business income (earnings - business expenses) in 2018 was $66,000 and she had no other sources of income like a W-2 job. Since Mary is below the income threshold for the "lesser of 20% of QBI or 50% of W-2 wages" test, she's entiteld to take the full 20% QBI deduction, or $13,200, which reduces her income by this amount before calculating taxes.


PROFESSIONAL SERVICES

Andrew is a partner at a divorce law firm in Boca Raton. Andrew is married, and their combined taxable income for 2018 after deductions is $500,000. Andrew's share of the partnership's income is $420,000 and his share of the W-2 wages of the law firm is $100,000. Andrew is entitled to no deduction, because a law firm is a specified service business and him and his spouse's taxable income exceeds $415,000, meaning he is completely phased-out of any possible deduction.

REAL ESTATE AGENT

Angelica is an indepedent real esate agent for Sotheby's who recently got married to her long-time boyfriend, Thom. Angelica runs her real estate business as a sole proprietor. In 2018, Angelica hired a full-time assistant to help manage her growing business at an annual salary of $50,000. During 2018, Angelica's business income was $200,000 (after subtracting business expenses like her assistant's salary), and Angelica and Thom's total taxable income, after deductions, is $280,000. Angelica is entitled to a deduction of $40,000 ($200,000 * 20%). The "W-2 wage limitation" – which would normally be $25,000 ($50,000 * 50%) does not apply because Angelica and Thom's taxable income is less than $315,000.

ENTREPRENEUR

Bill is the owner of a successful plumbing company, Bill's Plumbing LLC. His wife, Sarah, teaches first grade at the local elementary school. In 2018, Bill's Plumbing had net income of $400,000, and only one employee, a junior plumber earning a $50,000 salary. Bill and Sarah's taxable income in 2018, after all deductions, is $430,000. Because their income is above the $315,000 threshold, Bill is entitled to take only the lesser of 20% of QBI or 50% of total W-2 wages. Because 50% of W-2 wages is $25,000 and 20% of QBI is $80,000, Bill's business income deduction is limited to $25,000.

INFORMATION ON OBTAINING AN EIN

  • On January 1, 2018 and beyond, owners of sole proprietorships, partnerships, LLCs, and S Corporations can qualify to take a deduction equal to 20% of the "qualified business income" earned from the business.
  • The deduction can only be applied to "qualified business income" (QBI for short) which can be defined as the normal operating income of the business (operating revenue minus business expenses). QBI does not include capital gains, interest, or dividend income.
  • Business owners in any industry with taxable income less than $315,000 or $157,500 (married/single) in 2018 can take the full 20% deduction against their QBI. Limitations to the deduction start to apply once taxable income exceeds these amounts.
  • Above $415,000/$207,500 (married/single), business owners can only take the lesser of: 20% of qualified business income, or 50% of the total W-2 wages paid by the business.
  • Additionally, once taxable income surpasses the defined thresholds, only certain types of businesses are allowed to claim the QBI deduction. In general terms, any business involved in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services is defined as a "specified service business" disallowed from taking the deduction. The law also excludes businesses "where the principal asset of such trade or business is the reputation or skill of one or more of its employees [or owners].”
  • The complete rules and restrictions of the qualified business income deduction are complex and not fully defined yet by regulatory bodies. Many of the exceptions and intracies of the law are not discussed on this page. For full details and advice on how the rules might affect your personal tax situation, we always recommend consulting a dedicated tax adviser.

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