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Qualified Business Income (QBI) Deduction

Qualified Business Income (QBI) Deduction

The QBI (qualified business income deduction) allows individuals to deduct up to 20% of business income, REIT dividends, or PTP income from personal income tax returns. Those who are eligible to claim the QBI deduction include partners in a partnership, shareholders of S corporations, sole proprietors, and certain funds and properties.

The QBI deduction reduces taxable income, which is used to determine the annual income tax payable. Taxpayers can claim the deduction by taking the standard deduction or by itemizing their deductions.

The maximum possible deduction is limited when a certain limit on taxable income is reached. Working in certain industries or businesses may also affect the deduction available. Only domestic business revenue is eligible, and you may receive a copy of Schedule K-1 if you have an eligible QBI.

The QBI deduction was created by the TCJA, a major overhaul of the Federal Tax Code. Section 199A specifies the deduction, so you can also see it as the Section 199A deduction. The deduction has also changed in just two years since its existence. Form 8995 or Form 8995-A is now required.


Who can claim the QBI Deduction?

To be eligible for the deduction, the taxpayer must have taxable income from one of the following:

  • Eligible REIT dividends, which include most normal REIT dividends

  • Eligible PTP income or losses, including only your share of the partnership's income and losses

  • Some pass-through entities pass income tax on to their owners instead of paying corporate tax rates

You may still be eligible if you have one of these three but not the other two. You also don't need to itemize deductions to claim deductible income from a qualifying business. This means that as long as you are eligible for the deduction, you can accept it. This is different for itemized deductions, such as medical expense deductions, which you can only claim if you qualify and for a certain amount of total itemized deductions.

Qualified income businesses must provide the necessary information to shareholders or their members in Schedule K-1.


Which pass-through entities are eligible?

Some companies, called pass-through entities, do not pay a corporate tax rate. Instead, business income is transferred to individual owners, who share and pay taxes on individual income tax returns and any other personal income they hold. In this scenario, the business itself is a taxable entity, according to the IRS. Taxable entities can also include items such as organizations and trust funds. 

Pass-through entities that can claim the QBI deduction include

  • LLC members

  • Owners of a fund or property

  • Partners in Partnership

  • Shareholders of S Corps

  • Sole proprietorships

C Corps are not qualified for the deduction, even if they are considered as pass-through entities. You are also not eligible for the income you earn as an employee.

Remember that the QBI deduction is for individuals. For example, an S corporation cannot make the deduction, but its shareholders. Likewise, agricultural and horticultural cooperatives are not eligible, but members who receive a dividend or payment from the cooperative may.


What is a qualified business income?

Eligible business income is the taxable income from a domestic business. If the business also has foreign income, only national domestic income will be eligible.

Eligible business income does not include the following:

  • Capital gains or losses

  • Dividends qualified as REIT (real estate investment fund)

  • Exchange gains or losses

  • Income that was not received in the course of the activity.

  • Income, losses, or deductions from a notional principal contract (NPC)

  • Interest income

  • Most investment dividends

  • Non-taxable income, such as interest on municipal bonds

  • Publicly traded partnership (PTP) income

  • Salaries or wages of employees

For help finding out if your income qualifies for the QBI deduction, consider speaking with an accountant or tax lawyer.


REIT dividends and PTP income

For this deduction, eligible REIT dividends include most of the REIT dividends that people earn. You can find the value of eligible REIT dividends in box 5 of a 1099-DIV.

For a REIT dividend to be eligible, it must have been held for more than 45 days, the payment must be for you, and it cannot be a capital gains dividend or a generally qualified dividend. An instance of a REIT dividend that may not qualify is one in which the REIT has sold its underlying property and generated a capital gain.

The eligible income of a PTP includes its share of the income, profits, deductions, and losses of a PTP.


How much does the QBI deduction cost?

The total QBI deduction is less than

  • 20% of qualifying business income, plus 20% of qualifying REIT dividends and qualifying PTP income, OR

  • 20% of taxable income minus net capital gain

The exact amount of the deduction depends on the amount of your income. As long as your taxable income, before considering the QBI deduction, is below the income limit, you can claim up to the full deduction.

If your taxable income is above the limit, the maximum possible deduction is limited. The amount you can get will decrease depending on your income. Use the worksheets in the instructions for Form 8995-A to calculate the exact deduction. The deduction considers several factors, and the instructions will walk you through them, or you can enlist the help of a tax professional.

Income from a specified service trade business or business (SSTB) is not eligible for the QBI deduction after exceeding the income limit. 

Once you reach a specific income limit, you are no longer entitled to a deduction. Your marital status determines the limits for filing purposes. You can see the term phased-in limit or phased-in range to describe the income deduction between the threshold and the upper-income threshold.


QBI Income Deduction Limits 2020

Filing Status

Income Threshold (limit for the full deduction)

Income Limit For A Partial Deduction

Single

$163,300

$213,300

Head of household

$163,300

$213,300

Married filing jointly

$326,600

$426,600

Married filing separately

$163,300

$213,300

Married nonresident alien

$163,300

$213,300

 

 The table above applies to the 2020 taxes that you will file at the beginning of 2021. For the 2021 taxes you will declare at the beginning of 2021, the threshold value will increase to $ 329,800 for couples filing together, and $ 164,925 for married filing separately, and $ 164,900 for all other tax filing statuses.


SSTB

Once the QBI deduction limit is exceeded, the maximum possible deduction will decrease until you are no longer eligible. Income from an SSTB is not eligible. An SSTB is a business or enterprise that provides services in any of the following areas:

  • Accounting

  • Actuarial science

  • Advice

  • Athletics

  • Financial services

  • Health services, such as those provided by doctors and nurses.

  • Intermediation services

  • Investments management and investing 

  • Law, including lawyers

  • Performing arts

  • Trade


Other types of ineligible businesses

In addition to SSTB, income from these sources does not qualify for the QBI deduction:

  • Any business or enterprise whose main asset is the reputation or skills of one or more employees or owners.

  • C Corps 

  • Services you provided as an employee of another person or company


How to claim the QBI deduction

Start by collecting the necessary documents showing your qualifying income. Most people will have a copy of the K-1 program, with the required info attached.


Find your AGI

Next, you need to determine your taxable income. You can do this by looking at the first eight lines of Form 1040 to find Adjusted Gross Income (AGI). Using the services of a qualified tax professional or an online tax filing service will help you calculate this amount.


Use Form 8995 or 8995-A

If you claim the QBI deduction for 2020, you will need to complete Form 8995 or Form 8995-A. Use Form 8995 if your taxable income is smaller than the income limit shown in the table above. Complete Form 8995-A if the taxable amount is greater than the income limit shown in the table above. Attach the Form 1040.

Both Forms walk you through adding qualifying business income, qualifying REIT dividends, and qualifying PTP income. Then determine the amount of the deduction. The calculation itself is relatively straightforward.

Please note that this deduction does not affect any other taxes or forms that you must include with your return. For example, the QBI deduction does not reduce self-employment tax. If you have rental income, even though you are eligible for the QBI deduction, you will likely need to report it on Schedule E. If you are a sole proprietor with business income or loss, you still need to submit Schedule C.


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