By: Amir Naghshineh-Pour
April 19, 2021
This new provision, first applicable for 2018 and also known as the QBI deduction, allows a deduction of up to 20% of qualified business income, along with a special 20% deduction for certain investment income. The deduction is available, regardless of whether an individual itemizes his/her deductions or take the standard deduction. This deduction sunsets after 2025, unless Congress decides to extend it.
The deduction only applies to income from pass-through entities. Sole proprietors, partners in partnerships, LLC members, beneficial owners of trusts, estates, and shareholders in S corporations may be eligible for this deduction. Income earned through a C corporation is not eligible for the 199A deduction.
The 199A deduction only applies to domestic income, therefore the deduction is generally available only to US businesses. For businesses with both US and foreign operations, the income must be allocated properly between foreign activity and domestic activity to calculate the QBI deduction. The 199A deduction has two components:1. QBI Component: This component of the deduction equals 20% of qualifying business income from a domestic business operated as a sole proprietorship, or through a partnership, S corporation, trust, or estate.2. REIT/PTP Component: This component of the deduction equals 20% of the combined qualified REIT dividends and qualified PTP income.
Once a taxpayer adds the two components above together, the taxpayer’s Section 199A deduction is subject to an overall limit of 20% of taxable income less net capital gain. Net capital gain includes net long-term capital gain and qualified dividend income.
Qualified Business IncomeIncludes items of income, gain, deduction, and loss from any domestic trade or business activity, including rental activities that rise to the level of a trade or business. Bear in mind that the Section 199A deduction does not reduce self-employment taxes, excise taxes, or penalties. It is only an income deduction.
The determination of QBI includes deductions attributable to the trade or business, including, but not limited to, the deductible portion of the self-employment tax, the deduction for self-employed health insurance, and contributions to qualified retirement plans. A qualified business loss results in no QBI deduction for the taxable year. The QBI loss carries over to subsequent years and reduces the section 199A deduction for QBI for those future years. The section 199A loss carryover is solely for purposes of section 199A computations.
In general, the 199A deduction is available to eligible taxpayers whose pre-QBI deduction taxable income falls below certain amounts. The 2020 QBI threshold and phase-in range are as follows:MFJ: $326,000 - $426,000MFS: $163,300 - $213,300Single, HOH and QW: $163,300 - $213, 300
When a taxpayer falls below the taxable income threshold, the taxpayer is generally allowed to take the deduction without regard to any limitations.The 199A deduction for taxpayers above the taxable income threshold is partially subject to various limitations and may be limited or eliminated. For taxpayers with taxable income that exceeds the phase-in range, the deduction is subject to limitations based on:- The type of trade or business, (the “Specified Service Trade or Business” or “SSTB” limitations)- The amounts of W-2 wages paid and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business by the qualified trade or business (the “wage and property limitation”).
If a taxpayer’s income is below the income threshold, then the business will generally qualify for the 199A deduction. However, if a taxpayer’s income is above this threshold, then limitations may apply. The “SSTB limitations” is a limitation that applies to certain business types only. If the taxpayer’s income is above the threshold, and the business income is from a “specified service business” then the deduction is completely disallowed.
If the taxpayer’s income is above the phase-in range, and the business is not a specified service business, the deduction is limited to the lesser of”- 20% of QBI or- The greater of : 1- 50% of qualifying W-2 wages paid by the business, or the sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property of the business.
Safe Harbor Rule for Rental ActivitiesThe IRS provides a safe harbor under which a rental real estate activity will constitute a “trade or business” for the purposes of the QBI deduction. For the taxpayer to quality for the safe harbor, 250 or more hours of service must be provided per year to each rental real estate enterprise, in any three of the five consecutive taxable years.
REIT Dividends and PTP IncomeEligible taxpayers may also be entitled to a special deduction of up to 20% of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This component is not limited by W-2 wages or the UBIA of qualified property.
QBI: Potential for Tax SavingsThe QBI deduction presents an attractive opportunity for eligible business owners to maximize their tax savings. Please note that the following adjustments could also affect QBI: SEP IRA contributions, half of the self-employment (SE) tax deduction and SE health insurance.
Consult with USThe QBI deduction rules are complicated, so it’s a good idea to consult with your wealth advisor to evaluate which strategies may be the most effective for your financial situation. Or for for free consultation reach out to us.
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