As the first tax return filing season under the newly minted Tax Cut and Jobs Act (TCJA) has passed, one thing has become clear, there is nothing clear about the qualified business income deduction (QBID).
The QBID is seen as the small business equivalent to the tax rate decrease provided to C Corporations under the TCJA. The corporate taxpayers saw their rates fall from an adjustable rate maximum of 35% to a flat 21% tax rate.
The QBID was placed into law by the TCJA and is administered under Internal Revenue Code Section 199A. Important to note, the deduction is currently temporary, unlike the permanent rate change for C Corporations, and will expire at the end of 2026, barring any tax extenders being signed or permanent status being granted to the law.
The QBID is significant, as it allows for a potential 20% deduction to business income for non-corporate taxpayers that report net qualified business income.
When determining if the QBID is applicable to a taxpayer, two questions must be asked:
1. Am I an eligible taxpayer?
2. How much of a deduction may I claim?
The QBID is claimed by an eligible individual taxpayer with a business interest in a proprietorship, partnership, S corporation, limited liability entity, and/or in certain trusts.
However, the law carves out as ineligible many of the traditional professional service businesses, for example healthcare, attorneys, accountants. The law refers to these taxpayers as Specified Service Trade or Businesses (SSTB) and generally speaking, this applies to those professions where the “item” being sold is the knowledge of the seller.
An individual taxpayer with an SSTB interest is only eligible to take the QBID until their income reaches a certain level. For purposes of this article, I will mention that the maximum allowable income for an SSTB to take the QBID currently ranges from $160,725 to $321,400, for married taxpayers filing a joint return. Lower limits apply to other types of filers.
Once your eligibility has been determined, the next consideration is the calculation of the deduction. In its simplest form, the deduction is equal to 20% of a taxpayer’s net qualified business income. This of course is also not as simple as it seems.
The QBID calculation has multiple limiting factors, including income thresholds, net combined income from all QBI activities as well as wages paid from qualified business income entities and the adjusted value of the fixed assets from those businesses. These factors, and others, can easily reduce or eliminate the 20% deduction.
After one year of implementation, it is clear that the Section 199A deduction is highly beneficial when applicable; however, the QBID is an extremely complicated area of the TCJA and has potential pitfalls for those unknowledgeable of all its complexities.
The tax professionals at McClintock and Associates have taken the necessary steps to make ourselves an expert in the application of this new tax law and we are always here to assist with any questions you may have. Please feel free to reach out to a member of our tax team with your questions.