Can You Claim The Qualified Business Income Deduction?
The qualified business income deduction is a tax deduction for eligible small businesses/self-employed individuals that allows taxpayers to deduct up to 20% of qualified business income from their tax returns. Are you eligible?
If you’re a small business owner or are self-employed, it’s important that you take advantage of all tax credits and deductions when it’s time to file your annual income tax return. For many businesses and self-employed individuals, this includes the qualified business income deduction (QBID).
In this post, we’re going to break down exactly what this deduction is and who qualifies. We’ll explore how to calculate the deduction, as well as answer some frequently asked questions.
Keep reading to learn more about the qualified business income deduction and how it could affect your next tax return.
Table of Contents
- What Is The Qualified Business Income Deduction?
- Who Qualifies For The Qualified Business Income Deduction?
- What Counts As Qualified Business Income?
- How The Qualified Business Income Deduction Works
- Is There A Qualified Business Income Limit?
- How To Calculate The Qualified Business Income Deduction
- The Bottom Line On The QBI Deduction
- Qualified Business Income Deduction FAQs
What Is The Qualified Business Income Deduction?
The qualified business income deduction is a tax deduction for small business owners and self-employed individual taxpayers. This deduction is also referred to as the pass-through deduction and the 199A deduction. The QBID allows qualifying individuals and businesses to deduct up to 20% of qualified business income on their federal tax returns.
Additionally, qualified taxpayers can deduct up to 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
For the purposes of this post, we will be focusing only on the qualified business income component of this deduction.
Who Qualifies For The Qualified Business Income Deduction?
Certain self-employed individuals and small businesses are eligible for the qualified business income deduction. In order to receive this deduction, you must own a “pass-through” business. Income from the business is not taxed at the corporate level. Instead, any income from the business is passed through to the owner, who reports the income on their individual tax returns. The income is then taxed at the individual level.
Types of pass-through entities that are eligible to receive the qualified business income deduction include:
- Sole proprietorships
- Limited liability companies (LLCs)
- S corporations
Per the IRS, any section 162 trade or business is qualified for the QBID with the exception of the following:
- C corporations
- Performing services as an employee
- Specified service trades or businesses (SSTBs) that exceed income limitations
For businesses classified as SSTBs, the QBI deduction may be eliminated or decreased based on income.
What Counts As Qualified Business Income?
The IRS defines qualified business income (QBI) as the net amount of income, gain, deduction, and loss from a qualified trade or business. Only items included in taxable income are eligible, and all must be connected to a domestic trade or business.
Additionally, the IRS provides guidance on what is excluded from qualified business income.
- Capital gains & losses
- Interest income
- Certain dividends
- W-2 income
- Reasonable compensation from S corporations
- Guaranteed payments from a partnership
- Payments received from a partner for services under section 707(a)
If you are unsure of what qualifies as QBI, consult an accountant or tax professional.
How The Qualified Business Income Deduction Works
For most self-employed individuals and business owners, qualified business income will be the income or loss reported on one of these tax schedules:
- Form 1040, Schedule C: Line 31 – Net Profit (or Loss)
- Form 1040, Schedule F: Line 34 – Net Profit (or Loss)
- Form 1065, Schedule K-1: Box 20, Code Z – Qualified Business Income
- Form 1120-S, Schedule K-1: Box 17, Code V – Qualified Business Income
- Form 1041, Schedule K-1: Box 14, Code I
The QBID is a “below the line” deduction that reduces taxable income. It does not reduce adjustable gross income. It is available to taxpayers that itemize deductions, as well as those that take the standard deduction.
Taxpayers that fall below the income threshold will report the deduction on the Form 8995 Simplified Worksheet with Form 1040. Those with incomes above the threshold will report the deduction on Form 8995-A.
Is There A Qualified Business Income Limit?
There are some income limitations surrounding the QBID. For the tax year of 2021, these limits are:
- Single Filers: Up to $164,900
- Joint Filers: Up to $329,800
It’s important to note that these limitations apply to total taxable income, which includes your business income and all other income. If you meet or fall below these income guidelines, you may be eligible to deduct up to 20% of your taxable business income.
If your total taxable income is over these limits, there are a few tests outlined by the IRS to determine if you qualify for the QBID. The first of these tests is to determine if your business is a specified service trade or business (SSTB). An SSTB is a business that provides services in fields including health, law, accounting, performing arts, consulting, financial services, actuarial sciences, investing, athletics, and trading.
If your business is an SSTB, you may still qualify for the QBID provided you meet the income threshold. For these businesses, the limits on total taxable income are:
- Single Filers: From $164,900 to $214,900
- Joint Filers: From $329,800 to $429,800
There are additional tests that you can perform to determine if you qualify for this deduction. We’ll explain in more detail in the next section.
How To Calculate The Qualified Business Income Deduction
For most taxpayers, calculating the QBID isn’t too difficult, provided they fall below the income limits set by the IRS. For businesses that exceed these limits, determining eligibility and calculating the deduction can get a little tricky.
Here are the most important steps to take when calculating the qualified business income deduction.
Determine If You Meet The Income Limitations
In order to claim this deduction, you must meet the income limitations set by the IRS. As mentioned earlier, these limits are up to $164,900 for single filers, and up to $214,900 for joint filers for tax year 2021.
Calculate Your Deduction
If your business is not an STTB, you haven’t surpassed the income limits, and you meet all other requirements, you can calculate your deduction. The amount of your deduction is the lesser of:
- 20% of your taxable income after subtracting net capital gains OR
- 20% of your qualified business income plus 20% of your qualified REIT dividends and qualified PTP income
Report Your Qualified Income Tax Deduction On Your Tax Return
The qualified income tax deduction is reported on one of two worksheets included with Form 1040. Most taxpayers will use Form 8995, Qualified Business Income Deduction Simplified Computation. However, if your income exceeds the threshold discussed earlier, you will be required to use Form 8995-A, Qualified Business Income Deduction.
Additional Steps For Taxpayers That Exceed Income Limitations
For most taxpayers, calculating the QBID isn’t too much of a hassle. However, for businesses that exceed the income threshold, additional steps need to be taken to determine eligibility.
Fortunately, the IRS has outlined a number of different tests you can use to determine if you will be eligible to receive this deduction.
First, you will need to determine if your business is an SSTB. This includes jobs such as lawyers, accountants, doctors, and consultants. If you operate this type of business, you may still qualify for the QBID if your total taxable income falls within the phase-in range. (As a reminder, this is from $164,900 to $214,900 for single filers, and from $329,800 to $429,800 for joint filers.)
If your total taxable income does fall within these ranges, you have to use a calculation that includes your QBI, W-2 wages, and unadjusted basis immediately after acquisition (UBIA) of qualified property. These calculations can get extremely complicated, so we highly recommend enlisting the services of an accountant or tax professional if you’re facing this scenario.
The Bottom Line On The QBI Deduction
Most small business owners and self-employed individuals dread tax time, but you can lighten the burden by heading into tax season armed with knowledge, ready to lower your liability with deductions and credits. The qualified business income deduction is just one way that you can save on your taxes. It’s easy to qualify and can add up to substantial savings. If you’re unsure of whether or not you qualify or are unsure of how to claim this deduction, don’t hesitate to reach out to an accountant or tax pro for expert guidance.
And don’t forget to check out Merchant Maverick’s other tax resources, starting with The Complete List Of Small Business Tax Deductions, to maximize your tax-time savings. Good luck, and happy filing!
Qualified Business Income Deduction FAQs