Qualified Business Income Deduction And Who Is Eligible?

Qualified Business Income Deduction

The qualified business income deduction (QBI) is a tax break that allows self-employed and small-company owners to deduct up to 20% of their qualified business income from their taxable income.

What is a qualified business income deduction?

At the end of 2017, the Tax Cuts and Jobs Act formed a new business deduction known as the qualified business income deduction

What is the qualified business income deduction for?

This deduction is intended to lower the tax rate for pass-through entities and sole proprietorships

One of the Tax Cuts and Jobs Act’s main goals was to lower the corporate tax rate for C corporations, which was reduced from a top rate of 35% to a flat rate of 21%. However, the bulk of American businesses that are not constituted as C corporations do not benefit from a drop in the corporate tax rate. 

As a result, the qualified business income deduction was introduced to help pass-through enterprises and sole proprietorships decrease their effective tax rate.

Who is eligible for the deduction?

Business income 

To begin, you must have a source of business income. For this deduction, most income from a pass-through company, such as a partnership or an S corporation, is deductible, as is income from a sole proprietorship, which you report on Schedule C of your Form 1040.

Taxable income 

Second, you can determine what to do next by considering your taxable income, calculated prior to applying this deduction. You can get the deduction of 20% the lesser of your business income or 20% of your taxable income over your net capital gain if your taxable income is below a particular threshold amount, which is a defined dollar figure adjusted annually for inflation.

If your taxable income is above the threshold amount, then you can try taking two additional criteria.

The first criterion is based on your job or the source of your income. If your business income comes from a “specified service business,” you can’t use the deduction. 

What is a “specific service business”? It can be defined as a business that deals with health, legal, accounting, actuarial science, the performing arts, consultancy, athletics, financial services, or brokerage services.

For instance, if you are a doctor, a lawyer, or an accountant, and your income is over the threshold amount, you will not be eligible for this deduction. However, if your income is below the threshold, this restriction will not apply to you, and you will be able to claim the deduction. You may be entitled to a partial deduction if your income falls between the threshold and the phase-out amount.

The second criterion for taxpayers having taxable income above the threshold level is the qualifying wages and qualifying investment criterion.

Because the purpose of the deduction was to encourage business growth and job creation, a taxpayer’s ability to claim the credit is limited by one of two additional criteria. The taxpayer can choose to use either of these two criteria and will take whichever one results in a larger deduction for them.

The first criterion is that the limitation of the deduction is set to 50 percent of W-2 wages paid to the business’ employees. 

However, if the business does not have employees, the owner can choose to use the alternative test which has the deduction’s limitation of 25 percent of the W-2 wages paid to employees, plus 2.5 percent of the business assest’ cost. 

To sum up, the qualified business deduction is determined at 20 percent times the lesser of the two criteria – qualified business income or taxable income. 

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