Qualified Business Income (QBI) Deductions: Your Complete Guide [2020]

Starting in the 2018 tax year, the Tax Cuts and Jobs Act of 2017 allowed many small business owners to begin taking a new deduction: the qualified business income deduction. If your business is eligible, you could benefit from significant savings on your taxes. These benefits could last from now through the 2025 tax year – or longer, if Congress extends the deduction. Here’s what you need to know about qualifying for and claiming a QBI deduction for the 2019 tax year.

What is the Qualified Business Income Deduction?

The QBI deduction, also called the section 199A deduction, is available to certain pass-through business entities. This is a term used to describe businesses that are ultimately taxed through individual income tax, not corporate income tax. Pass-through business structures include:

• Sole proprietorships
• S-corporations
• Partnerships
• Trusts and estates
• Limited liability companies operating as sole proprietorships or partnerships

Through the QBI deduction, eligible business owners can deduct up to 20% of “qualified business income”. You may also be able to deduct 20% of qualified real estate investment trust (REIT) dividends, as well as qualified publicly traded partnership (PTP) income. You can take the deduction whether or not you itemize other deductions on your tax return. What exactly is qualified business income? The IRS defines it as “the net amount of qualified items of income, gain, deduction and loss from any qualified [U.S.] trade or business.” Items must be part of overall taxable income. Of course, there are limitations as to which businesses can take the QBI deduction. These are based on business type, the amount of employee wages paid and the cost of property the business recently purchased and put into use (known as “unadjusted basis immediately after acquisition,” or UBIA). Before you can calculate and claim your deduction, you have to figure out if you qualify.

Qualified Business Income Deduction Phase Out: Limitations

Income is the most basic eligibility requirement for the QBI deduction. For the 2019 tax year, your taxable income must be less than:

• $160,700 if filing as single
• $321,400 if married and filing jointly

In this case, taxable income includes income from all sources, including business income after expenses (net income). Taxpayers exceeding this threshold may still be eligible for a QBI deduction with certain W-2 wage restrictions. There are a few limitations that may apply, depending on the type of the business.

Service Businesses

Known as a “phase out,” these limitations only apply to “specified service or trade businesses.” According to the IRS, this includes businesses that involve performing services as part of the business model. This also includes any trade or business in which the skills and/or reputations of the laborers/technicians are considered the primary asset. The list can be somewhat confusing. If you’re unsure whether or not your business might be subject to these limitations, be sure to refer to the IRS guidelines, or consult with an experienced accountant. Businesses falling into service categories may still be able to deduct the greater of:

• 50% of all W-2 wages
• The sum of 25% of W-2 wages and 2.5% of UBIA

If your income reaches $210,700 (if you’re single) or $421,500 (if you’re married filing jointly), the limitations apply. When this is the case, you can no longer take a QBI deduction for your service business. You may also be subject to additional reductions if you’re a patron of “an agricultural or horticultural cooperative.”

Real Estate Rental Properties

There’s also a qualified business income deduction rule for rental property. This “safe harbor” provision allows landlords renting out properties as a business to take the QBI deduction if they:

• Maintain separate books for each rental real estate enterprise
• Perform 250 hours of “rental services” during the tax year for rentals existing less than 4 years
• Perform 250 hours of “rental services” in at least three of the past five years for other properties
• Maintain records of all service hours with descriptions, dates and the person who performed the services

Well, What About Side Hustles?

If you’re an employee of a business, your income doesn’t qualify. But if you operate a side hustle of which you’re the sole proprietor, you may be able to take a deduction on that income.

How to Calculate Your QBI Deduction

The IRS has released two qualified business income deduction worksheets for the 2019 tax year:

• Form 8995, Qualified Business Income Deduction Simplified Computation – for taxpayers whose income doesn’t exceed the threshold
• Form 8995-A, Qualified Business Income Deduction – a more detailed form for taxpayers who don’t qualify to use Form 8995

These are different than the qualified business income deduction 2018 forms, which were included in other publications. If your income falls below the threshold, you’ll use Form 8995 to calculate your deduction. The form walks you through the math for the 20% deduction. It also instructs you to calculate your total taxable income minus net capital gains. The lower of the two numbers is your final deduction. You’re free to choose whether to do these calculations for each of your businesses separately, or to combine them. Calculations are different if you’re the owner or partner of an S corporation or part of a multi-owner LLC. In this case, using a qualified business income deduction calculator to work out the math can be helpful. It’s important to note that the IRS has a long list of income types that aren’t considered qualified business income. These include:

• Capital gains and losses
•  Interest income that doesn’t go to the business
• Wages and guaranteed payments given to partners and shareholders
• Income earned from doing business outside the U.S.

Regardless of your industry or the types of income your business generates, your total QBI deduction can’t add up to more than 20% of your taxable income. If your qualified income is a loss, you’re required to carry it forward and deduct it from your qualifying income in the following tax year.

Clean Up Your Books to Get Your Full QBI Deduction

Following qualified business income deduction instructions is complicated enough without the challenge of wading through a year’s worth of disjointed and messy accounts.  Automated bookkeeping services from National Business Capital put the numbers you need at your fingertips come tax time. With all income and expenses recorded and properly categorized, you can easily calculate your QBI deduction without missing a penny. But unfortunately, even qualifying for a QBI may not address all of your tax woes. When you’re having difficulty managing tax funds with working capital, National can help! Our team of Business Financing Advisors can help you quickly and easily find the best rates, terms and amounts to grow your business.