What is the qualified business income deduction?

The Qualified business income deduction (QBI) allows self-employed and small-company owners to deduct up to 20% of their qualified business income from their taxes.

In general, to qualify, total taxable income in 2023 must be less than $182,100 for single taxpayers and $364,200 for joint filers. In 2024, the restrictions will increase to $191,950 for single taxpayers and $383,900 for joint filers.

If your company income exceeds that limit, the IRS uses intricate methods to assess whether you qualify for a full or partial deduction. This is how the qualifying business income deduction typically works.

Who qualifies for the qualified business income deduction?

The deduction is available to individuals with “pass-through income,” which is business revenue reported on a personal tax return. Entities that qualify for the qualifying business income deduction include:

• Sole proprietorships.
• Partnerships
• S Corporations
• Limited Liability Companies.

What is “qualified business income”?

The qualified business income deduction, by definition, pertains to “qualified business income” (QBI). Qualified business income is defined as “the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business”. In broad terms, that refers to your company’s net profit.

However, this does not mean that every business revenue qualifies. The QBI excludes:

• Capital gains or losses.
• Dividends
• Interest income.
• Income earned outside the United States.
• Certain salaries and guaranteed payments given to partners and shareholders.

How to qualify for the QBI deduction

If your total taxable income — income outside of business included — is at or below $182,100 for single filers or $364,200 for joint filers in 2023, you may be eligible for the 20% deduction on taxable business income. In 2024, the restrictions will increase to $191,950 for single taxpayers and $383,900 for joint filers.

However, if your income exceeds certain restrictions, the pain becomes much more severe.

Here’s why: Above certain income limits, your eligibility to claim the pass-through deduction is determined by the specific form of your business. Even if your firm qualifies, you may not be able to take advantage of the entire 20% tax savings since the qualifying business income deduction has been phased down for some enterprises.

If you’re over the income limit

If your income exceeds the cap, a few criteria will decide if you are eligible for the qualified business income deduction. Here is an example of such a test: Is your company a “specified service trade or business”? If you work as a doctor, lawyer, consultant, financial advisor, or actor, among other things, your business is classified as a “specified service trade or business”.

Many high-income earners in these sectors will be ineligible for this tax advantage, which expires in 2023 after you reach a total taxable income of $232,100 if you’re single and $464,200 if you’re married filing jointly. The 2024 limitations are $241,950 and $483,900, respectively.

Tests for pass-through enterprises that exceed the income limit:

If your business is a “specified service trade or business” in 2023 and your income ranges from $182,100 to $232,100 (single filers) or $364,200 to $464,200 (joint filers), there are some tests to determine whether you can claim the qualified business income deduction and, if so, how much it will be reduced. In 2024, these values will climb to $191,950 to $241,950 (for single filers) and $383,900 to $483,900 (for joint filers).

Similarly, if you own a firm with pass-through revenue that is not a “specified trade or business”: There are tests that determine how much you may claim for the deduction.

Specifically, the amount of your deduction is determined by a computation that takes into account the salary you paid to employees (including yourself) as well as the value of the business’s property. The higher the statistics, the more likely you are to qualify for the discount.

However, things become difficult very quickly. So, if your tax position falls into this category, now is a good moment to contact us at PSACPA!

How the qualified business income deduction works

Consider the following characteristics of the pass-through deduction:

1. There are two different 20% estimates. The qualifying business income deduction equals up to 20% of your taxable business income. However, the pass-through deduction cannot exceed 20% of your total taxable income.

This is how it works: You calculate your company revenue and costs on Schedule C as usual. And, as always, you report your adjusted gross income on Form 1040. Only after that do you begin computing the pass-through deduction.

2. If you do not itemize, you can still claim the deduction. That is, if you utilize the standard deduction, this deduction remains accessible to you.