The Tax Cuts and Jobs Act of 2017 (TCJA) contains a new tax benefit, providing taxpayers with a deduction of up to 20% of qualified business income (QBI) from a qualified trade or business that is operated as a sole proprietorship, partnership, S-corporation, estate or trust. As the highlighted portion of this definition suggests, the QBI deduction is restricted to income originating from a qualified trade or business, which the IRS defines as every trade or business other than:
- the trade or business of performing services as an employee, and
- any trade or business involving the performance of services in the fields of health, law, engineering architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or 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.
While this provision can be complex for taxpayers with taxable income above $157,500 in 2018, or $315,000 on a joint return, it is relatively straightforward for taxpayers with taxable income below these thresholds.
Example: Melanie Foster runs her business as a limited liability company (LLC). In 2018, her QBI (the net of her company’s business income, gain, deduction, and loss) is $140,000. On the joint tax return that Melanie files with her husband, their taxable income is $235,000. This taxable income is before the QBI deduction.
Here, Melanie can deduct $28,000 (20% of $140,000) from their taxable income. Note that this deduction doesn’t reduce the Fosters’ adjusted gross income (AGI), which can impact many areas on their tax return.
Entities eligible for deduction
Over the limits
For taxpayers with taxable income in excess of $157,500, or $315,000 for joint filers, the QBI deduction is limited to the greater of:
- 50% of W-2 wages paid by the qualifying trade or business, OR
- the sum of 25% of W-2 wages paid, plus 2.5% of the unadjusted basis immediately following acquisition of all qualified property.
As such, these taxpayers must begin by determining their QBI deduction separately for each qualified trade or business, and then compare this amount to the limitation described above. The lesser of the amount calculated and the deduction limitation is the QBI deduction.