“Qualified business income” (QBI or QBID) defined for the Code Section 199A pass-through deduction
For purposes of the Code Sec. 199A deduction, Qualified Business Income (QBI) for a tax year is the net amount of qualified items of income, gain, deduction, and loss relating to any of the taxpayer’s “qualified trade or business”.
It does not include any qualified real estate investment trust (REIT) dividends or qualified publicly traded partnership income. (Code Sec. 199A(c)(1))
Under the umbrella of Qualified Business Income, certain items of income, gain, deduction, and loss are identified as such to the extent that such items are effectively connected with the conduct of a trade or business within the United States under Code Sec. 864(c) (applied by substituting “qualified trade or business” for “nonresident alien individual or a foreign corporation” or for a “foreign corporation” each place it appears).
Said items are included or allowed in determining taxable income for the respective tax year. (Code Sec. 199A(c)(3)(A))
If the net amount of qualified income, gain, deduction, and loss relating to qualified trade or businesses of the taxpayer for any tax year is less than zero, the amount is carried over as a loss from a qualified trade or business in the succeeding tax year. (Code Sec. 199A(c)(2))
Exclusions
Certain exclusions apply, when calculating QBI. The following items are not taken into account as items of Qualified Business Income, gain, deduction, or loss:
- any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss;
- any dividend, income equivalent to a dividend, or Code Sec. 954(c)(1)(G) payment in lieu of dividends;
- any interest income other than interest income that is properly allocable to a trade or business;
- any Code Sec. 954(c)(1)(C) commodity transaction gain or loss or Code Sec. 954(c)(1)(D) foreign currency gain or loss (applied by substituting qualified trade or business for controlled foreign corporation);
- any item of income, gain, deduction, or loss relating to Code Sec. 954(c)(1)(F) notional principal contracts (determined without regard to the rules coordinating the notional principal contract rules with other categories of foreign personal holding company income and excluding items attributable to notional principal contracts entered into in Code Sec. 1221(a)(7) hedging transactions);
- any amount received from an annuity that is not received in connection with the trade or business;
- and any item of deduction or loss properly allocable to an amount described in any of the preceding items in this list. (Code Sec. 199A(c)(3)(B))
In addition, QBI does not include:
- reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered for the trade or business;
- any Code Sec. 707(c) guaranteed payment paid to a partner for services rendered for the trade or business; and
- to the extent provided in regs, any Code Sec. 707(a) payment to a partner outside of his partner capacity for services rendered for the trade or business. (Code Sec. 199A(c)(4))
Qualified Business Income Deductions
The deduction is 20% of your QBI from a partnership, S-corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business.
The business must be conducted within the U.S. to qualify, and specified investment-related items are not included (e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business).
The trade or business of being an employee does not qualify. Additionally, QBI does not include reasonable compensation received from an S-corporation or a guaranteed payment received from a partnership for services provided to that partnership's business.
The QBI deduction is taken “below the line;” i.e., it reduces the business’ taxable income, but not its adjusted gross income.
However, it is available regardless of whether deductions are itemized, or the standard deduction is taken. In general, the deduction cannot exceed 20% of the excess of taxable income over net capital gain.
Note that, if QBI is less than zero, it is treated as a loss from a qualified business in the following year. Rules (discussed below) are in place to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction.
For taxpayers with taxable income above $157,500 ($315,000 for joint filers), an exclusion from the Qualified Business Income of income from “specified service” trades or businesses is phased in. These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners.
Here's how the phase-in works:
If taxable income is at least $50,000 above the threshold (i.e., $207,500 ($157,500 + $50,000), all the net income from the specified service trade or business is excluded from QBI. (Joint filers would use an amount $100,000 above the $315,000 threshold, viz., $415,000.)
If taxable income is between $157,500 and $207,500, the only exclusion allowable is that percentage of income derived from a fraction the numerator of which is the excess of taxable income over $157,500 and the denominator of which is $50,000.
For example, if taxable income is $167,500 ($10,000 above $157,500), only 20% of the specified service income would be excluded from QBI ($10,000/$50,000). (For joint filers, the same operation would apply using the $315,000 threshold, and a $100,000 phase-out range.)
Additionally, for taxpayers with taxable income more than the above thresholds, a limitation on the amount of the deduction is phased in, based either on wages paid or wages paid plus a capital element.
Here's how it works:
If taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), the deduction for QBI cannot exceed the greater of
- 50% of taxpayer's allocable share of the W-2 wages paid with respect to the qualified trade or business, or
- the sum of 25% of such wages, plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate).
Therefore, if QBI is $100,000, leading to a deduction of $20,000 (20% of $100,000), but the greater of (1) or (2) above was only $16,000, the deduction would be limited to $16,000 (i.e., it would be reduced by $4,000). And, if taxable income is between $157,500 and $207,500, it only would only incur a percentage of the $4,000 reduction, with the percentage worked out via the fraction addressed in the preceding paragraph. (For joint filers, the same operations would apply using the $315,000 threshold, and a $100,000 phase-out range.)
Other limitations may apply in certain circumstances; for example, for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
For more information about Qualified Business Income, or for a CPA firm that goes above and beyond, contact PIASCIK to set up a consultation. We’ll meet with you to show you all the benefits of being a PIASCIK client.
