What is the qualified business income deduction?
Simply put, the qualified business income deduction (QBID), aka the Section 199A deduction, lets business owners deduct up to 20% of their qualified business income (QBI). Part of the Tax Cuts and Jobs Act of 2017 (TJCA), the QBID was put into place to help out owners of small pass-through businesses. This IRS deduction remains open for small business owners through the 2025 tax year and can be used in addition to typically allowable deductions for business expenses. Keep in mind that eligibility for the QBID depends on the total income of the small business owner, whether earned through the small business or not.
Who qualifies for the qualified business income deduction?
Owners of pass-through businesses can typically claim the qualified business income deduction. Pass-through businesses don’t pay federal income taxes themselves. Instead, owners of pass-through businesses add and pay taxes on their business income via their personal tax returns. These types of small businesses include:
- Sole proprietorships and single-owner LLCs who file with Schedule C
- Multimember LLCs and partnerships filing partnership returns
- S corporations that file Form 1120-S
- Shareholders of ineligible S corporations that file Schedule K-1
- Some estates and trusts
- Individuals who receive qualified REIT dividends or PTP income
What are the income limitations for claiming QBID?
For the 2020 tax year, QBID claimants must earn under $163,300 for single filers, and joint filers can make up to $326,600 and still qualify. Single and joint filers may claim $164,900 and $329,800 respectively for the 2021 tax year. To keep up with rising costs of living and doing business, this amount is flexible for years 2022 to 2025. Keep in mind that those earning more than the qualifying amounts may still be able to claim a lesser amount, depending on whether they meet the threshold requirements set forth by the IRS.
How does the QBID work?
Available through the 2025 tax year, the QBID works by giving certain businesses a 20% deduction of qualified income. Individuals wishing to claim the Section 199A deduction don’t need to fill out additional forms on their tax returns, but they can use Form 8995, located in the instructions for IRS Form 1040, or Form 8995-A, located in Publication 535, to calculate their particular QBI deductions. The QBID doesn’t reduce earnings subject to self-employment taxes under Section 1402 or net investment income under Section 1411 of the IRS tax code.
How do I determine if I qualify for QBID for RREEs?
When deciding if your RREE qualifies for QBID, you must assess your small business against the safe harbor tests. These tests require you to keep separate books and records for each RREE and maintain records that document service hours, performed services, service dates and information about who performed the services. You must also perform 250 or more hours of rental services for each RREE, including:
- Advertising for rentals and leases
- Negotiating or executing leases
- Verifying information on tenant applications
- Collecting rent
- Performing everyday repairs and maintenance
- Making material purchases
- Supervising employees or contract workers
The QBID helps level the playing field by providing a fuss-free way for small business owners to reduce tax liabilities for business income claimed on personal income tax returns. Familiarizing yourself with the qualified business income deduction portion of the TCJA can help you keep more of your hard-earned money or provide funds to further grow your small business.
How is qualified business income deduction calculated?
The IRS provides the worksheets to calculate your qualified business income deduction in the instructions for Form 1040 and Publication 535. You can, however, figure your QBI deduction yourself without using those forms so that you know what to expect at tax time. Basically, if your qualified business income sits at or below the threshold and you meet all other requirements, your QBID is 20% of your QBI plus 20% of your qualified PTP income or REIT dividends. Keep in mind, the deduction comes into play after you subtract net capital gains from your QBI, but you can still claim normal business expense deductions in addition to the QBID.
How do I claim QBI deduction?
To claim the QBID, you must complete Form 8995 or 8995-A to calculate your deduction. You then add the amount you come up with alongside normal business expenses on the Schedule C form you submit with your completed tax return. It also helps to know that even if you don’t itemize your business expenses, you can still claim the QBID plus your standard deduction if you qualify based on all the other factors.
Who is not eligible for QBI?
Corporations themselves aren’t eligible for the QBID as the Section 199A deduction only applies to business owners. Those who run Specified Service Trades or Businesses (SSTBs), which includes businesses that rely on skills of one or more employees, including health care providers, law practices and accounting firms, may also not qualify for this deduction if the owners’ incomes rise above certain limits. Other ineligible earnings for QBID purposes include income from businesses located outside the U.S., business investment income, guaranteed partnership payments, nonbusiness interest income, dividends and dividend equivalents, W-2 income received by the owners of S corporations and capital losses or gains.
Does rental property qualify for the qualified business income deduction?
Per IRS Notice 2019-07, small business owners with rental real estate enterprises (RREEs) may claim the QBID. This safe harbor distinction defines RREEs as interest in real property held for rent production, and it can comprise interest in multiple properties. You may either treat each individual property held for rent production as separate businesses or all similar properties held for rent production as a single enterprise, but you can’t treat commercial buildings and residential properties as part of the same enterprise. Keep in mind that however you decide to set up your RREE deduction, you must treat it the same way from year to year when claiming QBID, outside major changes in circumstances.