The new 20% Qualified Business Income Deduction (20% QBID) is a HUGE tax break for most small business owners. In fact, this may be the biggest tax break to come down from Washington that mainly applies to small businesses in my 35+ year career.
Of course, this is also one of the most complex provisions, with many yet unanswered questions awaiting future IRS regulations and court case rulings for clarification.
To give you some idea of the complexity of the 20% QBID, the detail in Thomson Reuters Complete Analysis of the TAX CUTS AND JOBS ACT takes 12 pages to cover. A Cliff Notes version written by Tony Nitti (a Forbes contributor and author of Tax Geek Tuesday) runs 30+ pages.
On its surface, the 20% QBID gives owners of sole proprietorships, S-Corps, partnerships, and even owners of rental property reported on Schedule E a 20% deduction against their business income. This allows these business owners to retain their competitive tax rate advantage over C corporations. It was a 10% advantage before the new law and remains 10% after.
Qualified Business Income (QBI) is your share of income less deductions from the trade and business. It does not include capital gains or losses, dividends, non-business interest income, reasonable compensation (W-2 income), or guaranteed payments from partnerships. If you’re involved in multiple businesses, first calculate the deduction, subject to any limitations, on each business.
The deduction won’t reduce self-employment earnings or adjusted gross income, which is used to calculate many limits and phase-outs under tax law. Taxpayers won’t need to itemize to take the deduction.
But there are many special rules and restrictions designed to stop taxpayers from gaming the new law.
For taxpayers with income in excess of $315,000 for couples filing jointly and $157,500 for all others (after adding back the 20% deduction), the deduction is limited as follows:
- The income phases out for those in service fields where the principal asset is the reputation or skill of the employees. This includes health, law, accounting, consulting, financial services, performing arts, actuarial science, athletics, brokerage services, investing, or trading securities. The law here is very hazy and will require future IRS regulations to clear up.
- There is a W-2 wages limitation for high-income earners not in service fields covered above. This caps the deduction to W-2 wages and the basis of certain business assets.
The QBID is also limited to 20% of taxable income, excluding the 20% QBID and less any net capital gain. Additionally there are very complicated rules if a business has a loss.
If you own a business, and you want to make sure you maximize your 20% QBID, you must meet with a CPA or Enrolled Agent who specializes in tax planning before the end of the year.