In January of 2019, the IRS released the final regulations (RIN 1545-BO71) implementing the 20% deduction on “qualified business income” (the “QBI”) earned by a pass-through entity (the “QBI Deduction”), as enacted by Section 199A of the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The QBI Deduction was included in the TCJA in order to provide parity by mirroring the reduction in the corporate tax rate, which was reduced from 35% to 21%.
Pass-through entities are far more likely to be used by small business; pass-through entities, notably, provide greater flexibility in terms of how an entity can be structured and operated. Pass-through entities, unlike corporations, are not distinct separate taxpayers from their owners and, as such, any income, gain, loss, or tax liability “passes through” the entity to its owners. This is distinguished from the corporate form of taxation, whereby a corporation will pay 21% on any income earned and, additionally, the corporation’s executives, employees, and shareholders will also pay personal taxes on their income or capital gains that are derived from the corporation itself.
Does the QBI Deduction apply to my business?
There are certain limitations on the types of businesses the QBI Deduction applies to. Most importantly, a business must be a pass-through entity, as mentioned above, in order to be preliminarily eligible for the deduction. A pass-through entity includes sole proprietorships, partnerships, LLCs, and S-Corporations. Certain Trusts and Estates may also qualify for the QBI Deduction as well.
Further, the definition of QBI specifically excludes income from a “Specified Service Trade or Business” (an “SSTB”) if a taxpayer earns more than, if filing as single, $157,500, or, if filing as married filing jointly, $315,000. According to the IRS, professions that are considered to be a SSTB are professions that are “providing services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets, or any trade or business where the principal asset is the reputation or skill of one or more of its employees.”
How can I take advantage?
In order to take advantage of the QBI Deduction, a taxpayer must initially make two calculations to determine the amount of the deduction actually available. The first calculation is the sum of: 20% of QBI, plus 20% of any income from a qualified publicly traded partnership, plus 20% of dividends from a qualified real estate investment trust. The second calculation is the sum of: 20% of taxpayer’s taxable income (which is different from QBI in the first calculation), minus net capital gains. The lesser of these two calculations, accordingly, will be the amount that a taxpayer is eligible to deduct from its taxable income under Section 199A (thus, the amount of a taxpayer’s QBI Deduction).
To take advantage of the QBI Deduction after having made the calculations in the preceding paragraph, and any other applicable and necessary determination(s), a taxpayer should simply enter the value from the appropriate calculation (above) into Line 9 on Page 2 of taxpayer’s Form 1040 and, accordingly, proceed to calculate the taxpayer’s taxable income.
You can read the IRS Final Regulations for Section 199A at the following link: