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) or Section 199A Deduction. The actual calculation of the deduction was done in 2018 on one of two worksheets depending on the taxpayer's income. However, beginning in 2019, this deduction is calculated on two tax forms:
- Form 8995 - Qualified Business Income Deduction Simplified Computation, or
- Form 8995-A - Qualified Business Income Deduction.
For tax year 2020, a taxpayer with Qualified Business Income (QBI) will use the simplified Form 8995 if both of the following are true:
- Taxable income before QBID is at or below certain thresholds:
- MFJ filing status: $326,600
- Single, Head of Household, Qualifying Widow(er): $163,300
- The taxpayer isn't a patron in a specified agricultural or horticultural cooperative
Qualified Business Income
Whichever form is used to calculate the QBID, the underlying calculation starts with a separate determination of the QBI for each pass-through business that a taxpayer owns. Then the actual allowed deduction is made up of the QBI components of each pass-through business reported on the tax return.
The income or loss that qualifies for QBID is generally defined as income or loss that relates to the conduct of a business. It 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
For most individual taxpayers, the starting point for QBI is the income or loss that is reported by a pass-through business, and the entries that will generate the QBID are typically done on the menus or schedules that are used to report those business activities.
QBI is also reduced by the following:
- Deductible part of self-employment tax
- Self-employed SEP, SIMPLE, and qualified plans
- Self-employed health insurance deduction
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 1120S), and Schedule K-1 (Form 1041)) for additional information on how to enter the information on the Section 199A Deduction for that business.
Rental property held for investment purposes is not eligible for QBID. However, a taxpayer that holds rental property as a real estate business and can either meet the standard of an active real estate business or can satisfy the requirement of the Safe Harbor Election under Section 3.03 of Notice 2019-07 will be eligible to claim QBID.
Taxpayer Income Thresholds
When the taxpayer’s income, (including income that comes from a Specified Service Trade or Business (SSTB) is below the income thresholds (see above), 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 second provision is known as the "Income Limitation" and it 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 been reduced by any 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 restrictions which are discussed below. 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 an additional threshold:
- MFJ filing status: $426,600
- Single, Head of Household, Qualifying Widow(er): $213,300
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 of the QBID. 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 (10) 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 (10) 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 Publicly Traded Partnerships (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 Publicly Traded Partnerships (PTP) income (or loss), or
- the Income Limitation, which is 20% of the taxpayer’s taxable income minus net the capital gains and qualified dividends recognized on the return.
NOTE: This is an overview of the Qualified Business Income Deduction. This is not intended as tax advice.