The information in this article is up to date for tax year 2023 (taxes filed in 2024).
The 2017 Tax Cuts and Jobs Act brought about a significant overhaul of the American tax code. One provision that benefits many business owners is the Qualified Business Income Deduction (QBID), also known as Section 199A.
The provision allows certain sole proprietors, owners of S corporations and partnerships to deduct up to 20% of their qualified business income (QBI) from their taxable income as long as it comes from a qualified business or trade. In our three-part series on QBID, we’ve already covered the details on How the Qualified Business Income is Calculated and How a Specified Service Trade Can Impact QBID. In this post, we’re tackling the remaining FAQs on the technicalities of the QBID.
What is a Qualified Business?
Most passthrough businesses such as sole proprietorships, LLCs, partnerships, and S corporations are considered qualifying businesses. An exception is Specified Service Trades and Businesses (SSTBs), in which the principal asset is the reputation of an employee; examples include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading. These businesses can still qualify for the QBID but have different income limitations than other businesses. Find the details in our posts on How SSTBs Can Impact QBID.
What is Qualified Business Income?
Qualified business income (QBI) is defined by the IRS as the net number of qualified items of income, gain, deduction and loss from any qualified trade or business. Part of the QBID calculation also requires that business income be reduced by three items: deductible part of self-employment tax, the self-employment health insurance deduction and contributions to qualified retirement plans.
What is the REIT/PTP Component?
In addition to 20% of Qualifying Business Income, the deduction can also include 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
How does taxable income limit the QBID?
If a taxpayer’s only income comes from their passthrough business, they likely won’t be able to deduct the full 20% of their QBI. This is because the QBID must be the lesser of:
- 20% of the QBI component plus REIT/PTP component, OR
- 20% of the taxpayer’s taxable income before the QBID, minus the net capital gains and qualified dividends recognized on the return.
Their taxable income will be less than their QBI since taxable income is reduced by standard or itemized deductions and the deductible portion of the self-employment tax. They’ll likely only be able to deduct 20% of their taxable income before the QBID.
Are there other income limits?
This deduction can be limited by income requirements. For couples with married filing jointly status, their collective taxable income must be below $364,00, and for every other filing status, it must be below $182,100 in order to qualify for this deduction.
When the taxable income is above the threshold amounts, the deduction is subject to additional limitations according to the W-2 wages they paid and/or their Unadjusted Basis Immediately after Acquisition (UBIA) of qualified assets.
If the taxpayer is a Specified Service Trade or Business, the QBID is subject to the above limitations along with a phase-out reduction.
How do W-2 wages impact the QBID?
For businesses below the income threshold, W-2 wages don’t need to be considered at all. Businesses above the income threshold, however, will need to consider W-2 wages when calculating their qualified business income. Their QBI could be reduced by the greater of 50% of their W-2 wages OR 25% of their W-2 wages plus 2.5% of UBIA (more on that below).
What is Unadjusted Basis Immediately after Acquisition (UBIA) of qualified property?
The UBIA of qualified property is another way the deduction can be limited. This limits the QBID for businesses that may not pay a significant amount in W-2 wages but do hold a significant amount of property. To count as “qualified property,” the property must be tangible, subject to depreciation, and used to produce qualified business income. Because UBIA considers the value of the property “immediately after acquisition,” depreciation isn’t taken into account. However, property used to calculate UBIA must also still be within its depreciation period, which is ten years after it was first put into use by the business. Property that has surpassed this period is not included in the calculation.
UBIA becomes relevant to QBID calculation when 2.5% of the business’s UBIA plus 25% of the W-2 wages they pay is great than 50% of the W-2 wages. The UBIA should be included in the taxpayer’s schedule K-1.
With a strong understanding of these terms and basic rules, calculating QBID for your clients should become a relatively straightforward process. For more details on which forms to use and how to file for QBID, see our post on How the Qualified Business Income is Calculated.
