What is the qualified business income deduction?  

The qualified business income (QBI) deduction is a tax deduction for individuals who own and operate certain types of pass-through businesses, such as sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs).   

The QBI deduction allows taxpayers to deduct up to 20% of their QBI, the net income earned from their qualified business activities. This deduction is to provide tax relief to small business owners and entrepreneurs.  

There are several limitations and restrictions on the QBI deduction, including income limits, industry-specific limitations, and other factors. Additionally, the deduction is subject to change based on future tax laws and regulations. It is recommended that individuals must consult with a qualified tax professional for advice related to their unique circumstances.  

Who qualifies for the QBI deduction?  

 The QBI deduction was introduced as part of the Tax Cuts and Jobs Act of 2017 and is designed to provide a tax benefit to pass-through business entities.  

Your business should be a qualified trade or business, meaning it must be engaged in providing goods or services to customers. Certain types of businesses, especially those involved in performing services as an employee, specified investment businesses, and some other types of businesses, may not qualify for the QBI deduction.  

Your business must also generate income that qualifies for the QBI deduction. Generally, this includes income from sources of businesses, partnerships, S corporations, sole proprietorships, and real estate investment trusts (REITs). 

It’s important to note that various limitations and thresholds are associated with the QBI deduction, and the rules can be complex. It’s advisable to consult with a tax expert or accountant to determine whether your business qualifies for the QBI deduction and how much you can deduct.  

How QBI works? 

How to qualify for your QBI deduction, taxpayers must meet certain requirements:  

1. Be in a qualifying business

The QBI deduction is available to taxpayers engaged in a qualified trade or business. This includes most businesses not considered a specified service trade or business (SSTB). SSTBs include fields like health, law, accounting, and consulting, where the income is derived from the owners’ or employees’ reputation or skill.   

2. Have qualified business income

The QBI deduction is based on the qualified business income (QBI) generated by the qualifying business. QBI is generally defined as a qualified business’s net income, gains, deductions, and losses.  

3. Meet income thresholds

The QBI deduction is subject to certain income thresholds. For the tax year 2022, single filers with taxable income of less than $164,900 and joint filers with less than $329,800 are eligible for the full QBI deduction. 

Here’s an example to help illustrate how the QBI deduction works:  

Let’s say that Jack owns a construction business that generates $100,000 of qualified business income in 2022. Jack is married and files a joint tax return with his spouse, and they have a taxable income of $200,000.  

Because Jack’s construction business is a qualifying business and generates QBI, he is eligible for the QBI deduction. Based on his taxable and business income, he is also eligible for the full 20% QBI deduction, which amounts to $20,000 (20% of $100,000).    

So, after deducting the QBI deduction, Jack and his spouse’s taxable income is reduced to $180,000 ($200,000 – $20,000). This results in significant tax savings for Jack and his spouse.  

What are the limitations on QBI deduction?  

The QBI (Qualified Business Income) deduction is available to certain pass-through businesses, including sole proprietorships, partnerships, S corporations, and some LLCs. While this deduction can provide significant tax savings for eligible businesses, there are also several limitations on QBI deductions that business owners should be aware of. Here are some of the main limitations:  

1. Type of business

Not all businesses are eligible for the QBI deduction. For example, specified service businesses, such as law, accounting, healthcare, consulting, and financial services, may be subject to additional limitations or even excluded from the deduction entirely.  

2. Income thresholds

QBI deductions are subject to income thresholds. In 2021, the threshold for single filers is $164,900, and for joint filers is $329,800. Once your income exceeds these thresholds, the QBI deduction may be limited or phased out entirely.  

3. W-2 wages and capital investment

For some businesses, the amount of QBI deduction you can claim may be limited based on the wages paid to employees and the amount of capital invested in the business.  

4. Losses

If your business experiences a net loss for the tax year, you may not be eligible for a QBI deduction.  

5. Aggregation

If multiple businesses qualify for the QBI deduction, you can aggregate them and claim a larger deduction. However, certain requirements must be met to do so.  

It’s important to consult with a qualified tax professional to determine how the limitations on QBI deductions may apply to your business situation.  

Conclusion

In conclusion, the QBI tax deduction is a valuable benefit for small business owners and self-employed individuals. While the deduction rules can be complex, they can provide a significant tax break for eligible people. To claim the QBI deduction, individuals should ensure they meet the requirements set forth by the IRS, keep accurate records of their business activities, and work with a qualified tax professional to ensure they maximize their deductions. With the right planning and attention to detail, small business owners and self-employed individuals can take advantage of this valuable tax break and keep more of their hard-earned income.   

Also Read: How To File Taxes For An LLC In The U.S – Things To Know

Wajiha Danish

Wajiha Danish is the Director at Monily, overseeing financial strategies and operations for small and medium businesses. She has over 18 years of experience, including her role as Controller at HOCHTIEF PPP Solutions North America. Wajiha's background includes significant roles at Pakistan Petroleum Limited and A.F. Ferguson & Co. (PwC Pakistan). She is a Chartered Certified Accountant (ACCA) and Certified General Accountant (CGA) with expertise in financial management and project finance.