One of the more important provisions in the Tax Cuts and Jobs Act (2017) is Section 199A, the deduction for qualified business income (QBI). Section 199A allows a deduction for up to 20% of QBI from partnerships, limited liability companies (LLCs), S corporations, trusts, estates, and sole proprietorships. This deduction was first available in 2018.
Here are a few questions about QBID.
What is the Qualified Business Income Deduction (QBID)?
Section 199A of the Internal Revenue Code provides many taxpayers a deduction for Qualified Business Income from a qualified trade or business operated directly by the taxpayer or through what is known as a pass-through entity (for example, an S-corporation or partnership). This deduction is also known as the Section 199A Deduction.
QBID has two elements: a deduction of up to 20% of QBI subject to limitations, and a deduction of qualified REIT dividends and PTP income. The limitations on QBI include:
- the type of trade or business;
- the taxpayer’s taxable income;
- the amount of W-2 wages paid by the qualified business.
- the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business.
QBID is the lesser of:
- 20% of the combined qualified business income amount, or
- 20% of the taxable income minus the taxpayer’s net capital gain amount (if any).
Who is qualified to take the QBID?
Individuals and trusts and estates with qualified business income, and taxpayers who have qualified REIT dividends or qualified PTP income may be eligible to take the Qualified Business Income Deduction.
The QBID is available whether a taxpayer itemizes deductions on Schedule A or takes the standard deduction.
Income earned by providing services as an employee or earned through a C corporation is not eligible for QBID.
What is the definition of Qualified Business Income (QBI)?
QBI is the net amount of qualified income, gain, deduction, and loss from any qualified trade or business. The only items counted are those included in taxable income. The income must also relate to a U.S. trade or business. Items such as capital gains and losses, along with certain types of dividends and interest income are excluded from QBI.
What is the definition of a qualified trade or business?
A qualified trade or business is any trade or business, with two exceptions.
The first exception is for a Specified Service Trade or Busines (SSTB), which includes a trade or business involving the performance of services in the fields of:
- Actuarial science
- Brokerage services
- Financial services
- Investing and investment management
- Performing arts
- Securities trading and dealing
- Any trade or business where the principal asset is the reputation or skill of one or more of its employees.
This first exception only applies if a taxpayer’s taxable income is greater than the taxable income limitation for the tax year. See here for more information about the taxable income limitation.
The second exception is performing services as an employee.
How is the Qualified Business Income Deduction calculated?
QBID is the lesser of:
- 20% of the taxpayer’s qualified business income (QBI), plus 20% of the taxpayer’s qualified REIT dividends and qualified PTP income,
- 20% of the taxpayer’s taxable income minus any net capital gains.
The taxable income limitation does not apply to income from an SSTB if the taxpayer's income is under the limit.
If the taxpayer’s taxable income is above the taxable income limitation, QBID may be limited based on the following:
- Whether the business is a specified service trade or business (SSTB)
- The W-2 wages paid by the business
- The unadjusted basis of certain property used by the business
These limitations are phased in. See here for the phaseout thresholds.
Do the income thresholds get adjusted each year?
Yes, the income threshold amounts are adjusted each year based on the annual inflation adjustment determined by Congress.
When the taxpayer has income from a specified service trade or business (SSTB), how will that affect the deduction?
The SSTB limitation does not apply if the taxpayer's taxable income is below the taxable income limitations. For taxpayers whose taxable income is less than the phaseout threshold, the taxpayer’s share of QBI, W-2 wages, and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB.
Is rental real estate a qualified business?
It can be if the taxpayer is a real estate professional or if they satisfy the requirement of the safe harbor election under Rev. Proc. 2019-38. This revenue procedure outlines (a) the need for the taxpayer to keep separate books and records for the real estate activity, (b) the amount of time the taxpayer must devote to the real estate activity at a minimum, and (c) the need for the taxpayer to maintain contemporaneous records of their activity that relates to the rental activity. A taxpayer who meets the safe harbor election requirements must attach a statement to their annual tax return indicating this.
The taxpayer has taxable income under the taxable income limitation. Do they need to determine if their income is from an SSTB?
No. The taxpayer will be able to deduct the lesser of:
- 20% of their QBI plus 20% of your qualified REIT dividends and qualified PTP income,
- 20% of their taxable income minus net capital gains, if any.
The taxpayer has taxable income above the taxable income limitation but below the phaseout limit. Will it matter if their income is from an SSTB?
Yes. Because their taxable income is above the taxable limitation, QBID with respect to any SSTB will be limited. However, because they are under the phaseout amount, they will be allowed some QBID with respect to the SSTB.
Also, for taxpayers above the threshold amounts, QBID with respect to any trade or business, including an SSTB, may be limited by the amount of W-2 wages paid by the trade or business and the UBIA of qualified property held by the trade or business.
The taxpayer's only income is from an SSTB and is above the phaseout threshold. Are they entitled to QBID?
The taxpayer's income is not from an SSTB and is above the phaseout threshold. Are they entitled to QBID?
Yes. If they have QBI, qualified REIT dividends, or qualified PTP income. For eligible taxpayers with total taxable income exceeding the phaseout threshold, QBID may be limited by the amount of W-2 wages paid by the qualified trade or business and the UBIA of qualified property held by the trade or business.
How do S corporations and partnerships handle the deduction?
In general, S corporations and partnerships are not taxpayers and are not eligible for the deduction themselves. S corporations and partnerships report each individual shareholder’s or partner’s share of QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income on Schedule K-1 so the shareholder or partner may determine their QBID. (QBID is calculated at the shareholder or partner level, not at the entity level.)
Where is QBID claimed on Form 1040?
QBID is a “below the line” deduction on Form 1040. It is subtracted from Adjusted Gross Income as part of the calculation of taxable income. To claim the deduction, the taxpayer is required to attach Form 8995 or Form 8995-A to the 1040.
What specific items constitute Qualified Business Income (QBI)?
QBI is the net amount of the qualified items of income, gain, deduction, and loss with respect to the qualified trade(s) or business(es) of the taxpayer. QBI is determined for each qualified trade or business of the taxpayer.
QBI also includes operating income and income from rental activities (at least for real estate professionals and for taxpayers electing the Safe Harbor Election under Section 3.03 of Notice 2019-07)
Specific items excluded from QBI are:
- Any item considered when determining net long-term capital gain or loss.
- Dividends, income equivalent to dividends and any payment in lieu of a dividend.
- Interest income unless it is properly allocated to the trade or business.
- Guaranteed Payments from a partnership.
- Income that comes from “a qualified trade or business in the capacity of being an employee” or the “reasonable compensation amount” that an owner should receive as an employee.
What constitutes the "net amount" of "qualified items of income, gain, deduction, and loss"?
To correctly calculate the QBI, certain items that are associated with the income or loss generated by the pass-through business must also be deducted. These deductions include:
- The self-employment tax deduction which is connected to the income generated from the pass-through business (typically Schedules C and F or income from a partnership on Schedule E).
- The self-employment health deduction .
- Any contribution to a qualified retirement plan based on the self-employment income.
- Any unreimbursed partnership expenses claimed.
- Any charitable deductions made by the pass-through business that are reported on a Schedule K-1 and which the taxpayer claims as an itemized deduction on Schedule A of their tax tax return. Charitable deductions made by the pass-through business that are not claimed as an itemized deduction because the taxpayer takes the applicable standard deduction are not considered a deduction and netted against the taxpayer's qualified items of income, gain, and loss.
- The interest expense incurred by a taxpayer to purchase a partnership or ownership interest in an S Corporation.
How is the QBID calculated for amounts above the previously mentioned income thresholds?
Above the income threshold, the QBID is limited to the greater of:
- 50% of the W-2 wages with respect to the qualified trade or business,
- The sum of the following:
- 25% of the W-2 wages with respect to the qualified trade or business and
- 2.5% of the UBIA of all qualified property.
What if the taxpayer has more than one trade or business that is eligible for the QBID?
QBI is calculated separately for each business, then combined.
Are certain businesses eligible for the deduction regardless of the taxpayer’s income?
Income from a business that's not an SSTB is eligible for QBID regardless of the taxpayer's taxable income. Income from SSTBs that's above the threshold is not eligible for QBID.
What does “unadjusted basis immediately after acquisition” (UBIA) mean?
The basis of qualifying property is calculated as the unadjusted basis immediately after acquisition of that property.
Qualifying property means:
- tangible property;
- depreciable property;
- property that is available for use in the business at the close of the tax year;
- property used in the production of QBI at any time during the year;
- property for which the depreciable period has not ended before the close of the tax year.
If a taxpayer has taxable income above the higher phaseout threshold and owns a business that is not an SSTB, the QBI deductible amount for the business is subject to a limitation based on W-2 wages and/or capital, measured as the unadjusted basis of certain business assets.
The deductible QBI amount for the business is equal to the lesser of:
- 20% of the business's QBI, or
- The greater of: (a) 50% of the W-2 wages for the business, or (b) 25% of the W-2 wages plus 2.5% of the business's unadjusted basis in all qualified property.
What if the taxpayer's qualified business suffers a net loss for the taxable year? What happens to the QBID?
QBID cannot be taken in loss years. If QBI is less than zero in a year, the amount will be treated as a loss from a qualified business in the next year.
Note: This is a FAQ regarding the Qualified Business Income Deduction. This is not intended as tax advice.