If you own a business, you may have heard that the new tax law contains some favorable provisions for you. This blog will discuss the 20% Qualified Business Interest (QBI) deduction available to most owners who pay the taxes due on the business income on their personal tax return. This would include owners of businesses operating as sole proprietorships, partnerships, limited liability companies, and S corporations. Some estates and trusts are also eligible for the QBI deduction. The deduction is not eligible for business income earned through a C corporation.
All eligible business owners with taxable income, not including capital gains, of less than $315,000 for married filing joint or $157,500 for all others are eligible for the 20% deduction. The actual deduction, in this case, is the lesser of 20% of the taxable income shown on the tax return before the QBI deduction or 20% of the business income.
Let’s look at an example: A business owner is married and has taxable income (both she and her spouse) of $200,000. Her business income is $150,000. The QBI deduction is $30,000, which is the lesser of 20% of $150,000 (business income) or 20% of $200,000 (taxable income). If her business income were $250,000, the QBI deduction would be $40,000, which is the lesser of 20% of $250,000 (business income) or 20% of $200,000 (taxable income).
Once the taxable income, not including capital gains, is greater than $315,000 (or $157,500) and less than $415,000 for married filing jointly or $207,500 for all other taxpayers, the calculation has additional limitations. First, the business owner needs to determine if her business is a Specified Service Trade or Business (SSTB). For this new provision of the tax law, an SSTB is a trade or business performing services in the following fields:
- Actuarial science
- Performing arts
- Financial services
- Brokerage services
- Or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.”
If the business is not an SSTB, then the QBI deduction, with the higher taxable income, is further limited by the greater of 50% of wages or 25% of wages plus 2.5% of the original cost of assets owned by the business as of the end of the year. Using an example may make this easier to understand. A business owner is married, has taxable income of $200,000, $150,000 income from his business that is not an SSTB, paid wages of $50,000, and owns business assets with an original cost of $300,000. His QBI deduction is $25,000, which is the lesser of:
- $40,000 (20% of $200,000 taxable income)
- $30,000 (20% of $150,000 business income) or
- $25,000, the greater of:
- $25,000 (50% of $50,000 wages) or
- $20,000 [$12,500 (25% of $50,000 wages) plus $7,500 (2.5% of $300,000 in assets)]
If you’re confused about this new deduction or would like help applying it to your 2018 taxes, please let me know! I’d love to help. In our next blog, we’ll talk about the Qualified Business Interest Deduction for Specified Service Trades or Businesses. Thank you for reading!
Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.