It is a logical and desirable course of action for any business owner to put more than a little effort into minimizing their tax liability. However, business owners are often unaware of all the business tax deductions available under the federal tax scheme. Even if they are aware of the many tax deductions available, they may not be processing or maintaining the sufficiently detailed records necessary to use these deductions to their fullest advantage.
If you are a business owner, no matter what the type, size, and scope of your business enterprise, it is important to consult with a knowledgeable tax professional to ensure that you are using all tax deductions that are available to the greatest extent possible.
Many businesses may be eligible for a deduction under Section 199A of the Tax Code. This is more commonly known as the qualified business income (QBI) deduction. It applies to pass-through businesses such as a sole proprietorship, partnership, LLC (limited liability company), or S corporation. In addition to business enterprises, some trusts and estates may also claim this deduction under the Tax Code. The QBI was introduced as part of the 2017 Tax Cuts and Jobs Act (TCJA).
What is Qualified Business Income?
QBI is the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. This includes income from sole proprietorships, partnerships, S corporations, and certain trusts. However, these includable forms of income must be sufficiently connected with conducting a trade or business within the United States.
To compute QBI, a business owner should account for any deduction attributable to the trade or business such as the deductible portions of self-employed health insurance, self-employment tax, and deductions for contributions to qualified retirement plans.
How does the Qualified Business Income Deduction Work?
Taxpayers in the U.S. became eligible to claim the QBI for tax years beginning after December 31, 2017. In effect, taxpayers were able to first use it on their 2018 federal income tax returns. The deduction is available for taxpayers who itemize deductions on Schedule A or for taxpayers who take the standard deduction. The QBI deduction allows taxpayers to deduct up to 20 percent of their qualified business income, in addition to 20 percent of qualified publicly traded partnership (PTP) income and qualified real estate investment trust (REIT) dividends.
What are the Two Components of the QBI Deduction?
There are two components of the qualified business deduction. A component related to the QBI itself and a component related to qualified publicly traded partnership (PTP) income and qualified real estate investment trust (REIT) dividends.
The QBI Component
This component of the deduction equals 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. Depending on the taxpayer’s taxable income, the QBI Component is subject to limitations including the type of trade or business, the amount of W-2 wages paid by the qualified trade or business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business.
However, these limitations do not apply to taxpayers with taxable income at or below a certain threshold. For 2022, this threshold amount is $340,100 for a married couple filing a joint return, and $170,050 for all other taxpayers. Limitations are phased in for joint filers with taxable income between $340,100 and $440,100, and all other taxpayers with taxable income between $170,050 and $220,050.
The REIT/PTP Component
This component of the deduction equals 20 percent of qualified publicly traded partnership income and qualified real estate investment trust dividends. There is no limitation like the QBI component’s limitation for W-2 wages or the UBIA of qualified property. Federal tax law limits the qualifying amount of PTP income if the PTP engages in a specified service trade or business. The deduction requires a comparison of the sum of both the QBI and REIT/PTP components and 20 percent of the taxable income minus net capital gain. The deduction equals whichever is less of these compared amounts.
What Is a Qualified Trade or Business?
A qualified trade or business is any section 162 trade or business. However, there are three exceptions to this definition. The first is if the trade or business is conducted by a C corporation. The second exception applies to individuals who perform services as employees. Any income earned by a C corporation or earned by providing services as an employee is not eligible for the QBI deduction.
Specified Services Trades or Business (SSTBs)
The third exception relates to specified services trades or businesses (SSTBs). An SSTB is a trade or business that is service-based and depends on the reputation or skill of its employees or owners. It does not include engineering or architecture businesses but does include the performance of services in the fields of health, law, accounting, as well as many others.
However, this exception does not apply to taxpayers with taxable income at or below the threshold amount. Therefore, it only relates to taxpayers with taxable income that exceeds the threshold amount under the QBI.
If a business is an SSTB, the 20% QBI deduction is reduced or eliminated at income levels above the threshold amount. For 2022, the threshold amount is $340,100 for a married couple filing a joint return, and $170,050 for all other taxpayers.
The reputation or skill of its employees or owners is the principal asset of a trade or business if income is received from endorsing products or services. Also, reputation or skill is a principal asset of the business if the use of any symbol associated with the individual’s identity, such as an individual’s image, likeness, or voice, generates income. Public appearances through media outlets would therefore qualify.
What is the Threshold Amount for Taxpayer Deductions?
For 2022, the threshold amount is $340,100 for a married couple filing a joint return, and $170,050 for all other taxpayers. The deduction is phased out entirely when for individuals with income of $220,050, or married couples filing jointly with income of $440,100. These threshold amounts and phase-in ranges are regularly adjusted for inflation.
What is Not Included as Qualified Business Income?
Qualified business income does not include any of the following:
- Items that are not properly includable in taxable income such as losses or deductions disallowed under the basis, at-risk, passive loss, or excess business loss rules
- Investment items including capital gains or losses or dividends
- Interest income that is not properly allocable to a trade or business
- Wage income
- Income that is not effectively connected with conducting business within the United States
- Commodities transactions and foreign currency gains or losses
- Certain dividends and payments in place of dividends
- Income, loss, or deductions from notional principal contracts
- Annuities, unless received in connection with the trade or business
- Amounts received as reasonable compensation from an S corporation
- Amounts received as guaranteed payments from a partnership
- Payments received by a partner for services other than in the capacity as a partner
- Qualified REIT dividends
- Qualified PTP income
Safe Harbor for Rental Real Estate Businesses
A safe harbor is available to individuals and owners of passthrough entities as it relates to Section 199A. The safe harbor allows a rental real estate enterprise to be treated as a trade or business for purposes of the QBI deduction. If the rental real estate does not meet the requirements of the Section 199A safe harbor as a trade or business, it may still qualify for the QBI deduction if it is a Section 162 trade or business.
Talk to a Qualified Tax Professional
If you live in New York or the Tri-State area and have any questions about any tax-related issue, call 212-490-0704 today for a FREE consultation. You can also learn more online – THE TAX EXPERTS.
