The Tax Cuts and Jobs Act of 2017 created a deduction for certain pass-through business income known as the Qualified Business Income Deduction (QBID), also called the Section 199A Deduction.
In 2018, QBID was calculated on worksheets in Publication 535, but beginning in 2019 QBID is calculated on two tax forms:
- Form 8995 - Qualified Business Income Deduction Simplified Computation, or
- Form 8995-A - Qualified Business Income Deduction.
A taxpayer with Qualified Business Income (QBI) can use the simplified Form 8995 if both of the following are true:
- The taxpayer isn't a patron in a specified agricultural or horticultural cooperative.
- Taxable income before QBID is at or below certain thresholds:
Taxable Income Limitation MFJ MFS All others 2023 2022 $340,100 $170,050 $170,050 2021 $329,800 $164,925 $164,900 2020 $326,600 $163,300 $163,300 2019 $321,400 $160,725 $160,700 2018 $315,000 $157,500 $157,500
Otherwise, a taxpayer that is a patron in a specified agricultural or horticultural cooperative, or whose taxable income exceeds the above thresholds for their filing status, will use Form 8995-A.
Specified Service Trade or Business (SSTB)
It's important to know if a particular business is a Specified Service Trade or Business (SSTB), as income from a SSTB may be excluded from QBI subject to certain conditions. The IRS defines an SSTB as follows:
"Any trade or business where the principal asset is the reputation
or skill of one or more of its employees or owners."
These are the broad fields that are considered SSTBs, along with examples of each:
- Accounting - Tax return preparer, accountant, CPA, EA, financial auditor, etc.
- Actuarial Science - Actuary.
- Athletics - Athlete, coach, team manager, etc.
- Brokerage Services - Investment broker (not insurance or real estate).
- Consulting - Lobbyist, professional advisor, etc.
- Financial Services - Wealth manager, retirement or financial advisor, investment banker.
- Health - Dentist, doctor, nurse, pharmacist, physical therapist, psychologist, veterinarian, etc.
- Investment Management - Someone who provides investor services, e.g., investing in securities, advice on buying and selling investments, asset management, and investment management. (This does not include real property management.)
- Law - Arbitrator, lawyer, mediator, paralegal.
- Performing Arts - Actor, director, entertainer, musician, singer, etc.
- Securities Trading and Dealing - Securities dealer (as defined in section 475(c)(2)), commodities dealer (as defined in section 475(e)(2)), and dealer in partnership interests.
If it's unclear whether or not a taxpayer's business activity qualifies as an SSTB, here are some questions to consider that, in the affirmative, would point to the activity being an SSTB:
- Is the taxpayer compensated for endorsing products or services?
- Is the taxpayer compensated for the use of their image, likeness, name, signature, voice, trademark, or other symbol associated with them?
- Is the taxpayer compensated for appearing at an event or on media such as radio, TV, etc.?
Several de minimis rules apply if a business's profit is derived in part from SSTB and non-SSTB activity:
- If the business's gross receipts are $25 million or less and less than 10% of the gross receipts are from SSTB activity, then the business isn't considered an SSTB.
- If the business's gross receipts are more than $25 million and less than 5% of the gross receipts are from SSTB activity, then the business isn't considered an SSTB.
- If a non-SSTB and a SSTB share 50% or more in ownership, then the portion of the non-SSTB's business providing services or property to the SSTB is treated as a separate SSTB.
If the business is an SSTB, taxable income begins phasing out at the Taxable Income Limitations above then phases out completely at the thresholds below. Thus, income from a SSTB isn't included in QBI beyond these thresholds:
|SSTB Phaseout Thresholds|
Qualified Business Income
Calculating QBID begins with a separate determination of the QBI for each pass-through business that a taxpayer owns. Thus, for most individual taxpayers, the starting point for QBI is the income or loss that is reported by a passthrough business, and the entries included in the QBID calculation come from the menus or schedules that are used to report those business activities.
QBI does not include the following:
- investment income;
- guaranteed payments to partners for services rendered to the partnership;
- "reasonable compensation" paid to an owner for services rendered to the entity.
QBI is reduced by the following:
- Deductible part of self-employment tax;
- Deduction for contributions to self-employed SEP, SIMPLE, and qualified plans;
- Self-employed health insurance deduction.
- Unreimbursed partner expenses (as reported on Schedule K-1 (Form 1065) Box 14A).
- Any allowed section 179 deduction. ("Allowed" means the amount taken after applying the dollar limit and the business income limit.)
- Allowed charitable deductions reported on a Schedule K-1. ("Allowed" means the amount reported on Schedule A. No amount is allowed if the taxpayer is taking the standard deduction.)
For additional info on how to enter the Section 199A information in the pass-through business returns, see the specific knowledgebase articles on QBID for each of the pass-through businesses (Schedule C, Schedule E, Schedule F, Schedule K-1 (Form 1065), Schedule K-1 (Form 1120-S), and Schedule K-1 (Form 1041)).
Rental Property Income
Income from rental property held for investment purposes is not eligible for the QBID.
Income from rental property held in a real estate business is eligible for the QBID if:
- The activity meets the standard of an active real estate business, or
- The taxpayer satisfies 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.
Taxpayer Income Thresholds
When the taxpayer’s income, including income that comes from a SSTB, is below the income thresholds, the QBID will be the lesser of
- 20% of the net Qualified Business Income (or Loss) from all sources plus 20% of any qualified REIT dividends and Publicly Traded Partnership (PTP) income (or loss) recognized on the tax return, or
- 20% of the taxpayer’s taxable income minus the net capital gains and qualified dividends recognized on the return.
This income limitation has the effect of restricting a taxpayer with significant capital gains and qualified dividend income from receiving the QBID on the portion of their income that has already been given the favorable tax treatment afforded capital gains.
For taxpayers whose only income comes from pass-through businesses, the income limitation also has the effect of reducing the allowed QBID. This occurs because the taxpayer’s taxable income before consideration of the QBID will be lower than their income from the pass-through business because taxable income has already been reduced by certain adjustments to income, such as the deductible portion of self-employment taxes and the standard or itemized deduction.
Income Limitations on the Qualified Business Income Deduction
When the taxpayer's income is above the income thresholds, the QBID is subject to further limitations.
For taxpayers with income above the threshold amounts that have income from a SSTB, the QBID is phased out and eliminated once their taxable income reaches the thresholds above.
For higher income taxpayers above the income threshold, the QBI used in determining the QBID is limited based on W-2 wages paid by the business and/or the qualified assets used by the business. Specifically, for taxpayers with income above the thresholds, the first aspect of determining the deduction is the QBI Component.
The QBI Component is the lesser of the following:
- 20% of the QBI from the trade or business. If there are multiple pass-through businesses reported on the return, the QBI Component is determined separately for each business. Any business with a loss will have that loss allocated proportionately among the taxpayer's other pass-through businesses and the QBI for those other pass-through businesses will be reduced by the amount of loss allocated. Schedule C (Form 8995-A) is used to allocate losses among the QBI component for other businesses on the tax return.
- 50% of the W-2 wages paid by that trade or business to generate the QBI, or if greater 25% of the W-2 wages paid by the trade or business plus 2.5% of the unadjusted basis of the qualified property used by the trade or business. For this calculation, the unadjusted basis of qualified property is generally defined as (a) the original cost of assets that were placed in service by the business in the past ten years and still used by the business without regard to whether the asset has been fully depreciated or otherwise subjected to section 179 or bonus depreciation treatment and (b) the original cost of assets that are still being depreciated by the business because the depreciation recovery period is greater than ten years.
For higher income taxpayers, the QBI Component will be determined based on the above criteria to obtain a total QBI Component of all the separate pass-through businesses on the return. This total QBI Component will then be added to 20% of any qualified REIT dividends and/or PTP income (or loss) recognized on the tax return to obtain the QBID before the Income Limitation. Then the actual allowed QBID will be the lesser of:
- the QBI Component of all separately calculated businesses plus 20% of any qualified REIT dividends and/or PTP income (or loss), or
- the Income Limitation, which is 20% of the taxpayer’s taxable income minus the net capital gains and qualified dividends recognized on the return.
Note: This is a brief overview of the Qualified Business Income Deduction. This is not intended as tax advice. You are encouraged to read the Form 8995 and 8995-A instructions as well as other IRS information about the QBID.