Does Your Business Qualify for the new 20% Business Income Deduction? New Regs Provide Some Guidance but Calculations Still Complicated
December 6th, 2018
The new tax law lowered the corporate tax rate to a flat 21% starting in 2018. This corporate rate reduction helped out large companies, but most small businesses are organized as pass through entities where the income from the business passes on to the owners such as S corporations, LLCs, partnerships and sole proprietorships. To give a commensurate tax break to small businesses the new tax law also included a deduction for qualified business income (QBI) earned by pass through entities.
The rules related to the qualified business income deduction are the most complicated part of the new tax law and have several layers of qualifications and limits that have to be applied before you know if you actually receive any benefit. Below we list out the general rules but we encourage you to contact us to see if your business can benefit from this new deduction.
Income Limits – the Easy Part
If your taxable income is $315,000 or less for joint filers or $157,500 or less for single filers then you qualify for the 20% deduction for QBI from your pass through entity or sole proprietorship, regardless of whether or not it is a specified service business. There are no other rules or limits to apply. The 20% deduction is only applied to the QBI from the pass through entity income and not to the wages reported on a W2 issued to you by the pass through entity. If you fall within these income limits the QBI deduction will be allowed on your personal return.
Certain Service Businesses Do Not Qualify If Taxable Income Exceeds the Income Limits Described Above
There are several rules to note about who qualifies for the 20% QBI deduction and who does not.
• Businesses in the following service fields do not qualify for the QBI deduction: Attorneys, Accountants, Health Services, Consultants, Financial Advisors, Stock Brokers, Professional Athletes and Actuarial Services.
• Real estate brokers and insurance brokers do qualify for the QBI deduction.
• Consulting businesses that provide professional advice for clients to solve problems do not qualify for the QBI deduction but training and education businesses do qualify.
• The performance of health services means the provision of medical services by a physician, pharmacist, veterinarian, physical therapist, psychologist or similar professional. It does not include selling medical or pharmaceutical devises or health and fitness clubs.
• Even if your business is one of the outlawed service fields mentioned above you may still get a partial benefit as there is a phase out of the deduction from income levels up to $415,000 on a joint return and $207,500 for a single return.
You Qualify but Are Over Income Limits – Where Things Get Complicated
If you have pass through income that is not one of the excluded service businesses but your income is over $315,000 joint or $157,500 single then the math gets tricky. In this case your QBI deduction is limited to the lessor of 20% of your QBI or the greater of (1) 50% of the wages paid by your pass through entity or (2) 25% of the wages plus 2.5% of the basis of depreciable property from your pass through entity. There is also an overall limit of the QBI deduction equal to 20% of the overall income on your return over the net capital gain on your return. Pass through entities will provide the QBI information to you on the K1 you receive.