How the Qualified Business Income Deduction is Calculated

The Tax Cuts and Jobs Act created a new deduction for certain pass-through business income which is known as the Qualified Business Income Deduction (QBID). The calculation of the QBID is complex, requiring the preparer to apply technical rules, and it involves detailed recordkeeping on behalf of the taxpayer. The actual calculation of the QBID is done on one of two (2) worksheets, both of which are supported in the 2018 TaxSlayer Pro tax programs.

The specific worksheet used to calculate the deduction is primarily dependent on the taxable income (without consideration of the QBID) of the taxpayer. For taxpayers below the income thresholds of $157,500 (or $315,000 for Married Filing Jointly), the QBID will be calculated on the “Simplified Worksheet”. This Simplified Worksheet can be found in the Instructions for Form 1040 and is a straightforward calculation. However, for taxpayers with income at or above the taxable income threshold, the calculation is more complicated and is subject to additional limitations. For these higher income taxpayers, the QBID calculation is done on Worksheet 12-A which was released in draft form on December 19th in Publication 535. This draft form is currently only available at the IRS draft forms website, and because it is a draft, it may yet change. Also, there are limited situations, typically involving income from a specified agricultural or horticultural cooperative, which may require a taxpayer with income below the thresholds of $157,500 (or $315,000 for Married Filing Jointly), to use Worksheet 12-A.

Whichever worksheet is used to calculate the QBID, the underlying calculation starts with a separate determination of the “Qualified Business Income” (QBI) for each pass-through business that a taxpayer owns. The actual allowed QBID is made up of the qualified business income components of each pass-through business reported on the tax return. Basically, the income or loss that qualifies is generally defined as income or loss that relates to the conduct of a business and it does not include investment income, guaranteed payments to partners for services rendered to the partnership, or the “reasonable compensation” paid to an owner for services rendered to the entity.

For most individual taxpayers, Qualified Business Income will consist of the income or loss that is reported on any of the following tax schedules:

    1. Schedule C (Form 1040), Line 31 – Net Profit (or Loss)
    2. Schedule F, (Form 1040) Line 34 – Net Profit (or Loss)
    3. Schedule K-1 (Form 1065), Box 20, Code Z – Qualified Business Income
    4. Schedule K-1 (Form 1120S), Box 17, Code V– Qualified Business Income
    5. Schedule K-1 (Form 1041), Box 14, Code I – the fiduciary is required to provide a statement to the beneficiary with the Schedule K-1 (Form 1041) that specifies the portion of income that has been allocated to the beneficiary that is Qualified Business Income

Taxpayers that have income (or loss) from rental property will not be eligible for the QBID when they hold the property for investment purposes. However, a taxpayer that holds rental property as a real estate business and can meet the standard of an active real estate business under the new Section 199A regulations, will also include their rental income (or loss) amounts reported on Schedule E, Line 26.

When the taxpayer’s income, (including taxpayers that are considered Specified Service Businesses) is below $157,500 or $315,000 for Married Filing Jointly, the QBID will be the lesser of (1) 20% of the net Qualified Business Income (or Loss) from all sources plus 20% of any qualified REIT dividends and Publicly Traded Partnerships (PTP) income (or loss) recognized on the tax return, or (2) 20% of the taxpayer’s taxable income minus the net capital gains and qualified dividends recognized on the return. This second provision is known as the “Income Limitation” and it has the effect of restricting a taxpayer with significant capital gains and qualified dividend income from receiving the QBID on the portion of their income that has already been given the favorable tax treatment afforded capital gains. For taxpayers whose only income comes from pass-through businesses, the Income Limitation also has the effect of reducing the allowed QBID. This occurs because the taxpayer’s taxable income before consideration of the QBID will be lower than their income from the pass-through business because taxable income has been reduced by any adjustments to income, such as the deductible portion of self-employment taxes, and the standard or itemized deduction.

When the taxpayer’s income is above $157,500 or $315,000 for Married Filing Jointly, the QBID is subject to further restrictions which are discussed below. For taxpayers with income above the threshold amounts that have income from a Specified Service Business, the QBID is phased out and eliminated once their taxable income reaches $207,500 or $415,000 for Married Filing Jointly. How a Specified Service Business will calculate QBID will be the subject of Friday’s blog posting.

For higher income taxpayers above the income threshold, the QBI used in determining the QBID is limited based on W-2 wages paid by the business and/or the qualified assets used by the business. Specifically, for taxpayers with income above the thresholds, the first aspect of determining the deduction is the Qualified Business Income Component of the QBID. This QBI Component is the lesser of the following:

  1. 20% of the Qualified Business Income from the trade or business. If there are multiple pass-through businesses reported on the return, the QBI Component is determined separately for each business. Any business with a loss will have that loss allocated proportionately among the taxpayer’s other pass-through businesses and the QBI for those other pass-through businesses will be reduced by the amount of loss allocated. There is a separate schedule (Worksheet 12-A, Schedule C) required to allocate losses among the OBI component for other businesses on the tax return.
  2. 50% of the W-2 wages paid by that trade or business to generate the QBI, or if greater 25% of the W-2 wages paid by the trade or business plus 2.5% of the unadjusted basis of the qualified property used by the trade or business. For this calculation, the unadjusted basis of qualified property is generally defined as (a) the original cost of assets that were placed in service by the business in the past ten (10) years and still used by the business without regard to whether the asset has been fully depreciated or otherwise subjected to section 179 or bonus depreciation treatment and (b) the original cost of assets that are still being depreciated by the business because the depreciation recovery period is greater than ten (10) years.

For such higher income taxpayers, the Qualified Business Income Component will be determined based on the above criteria to obtain a total QBI Component of all of the separate pass-through businesses on the return. This total QBI Component will then be added to 20% of any qualified REIT dividends and/or Publicly Traded Partnerships (PTP) income (or loss) recognized on the tax return to obtain the Qualified Business Income Deduction before the Income Limitation. Then the actual allowed QBID will be the lesser of (1) the Qualified Business Income Component of all separately calculated business plus 20% of any qualified REIT dividends and/or Publicly Traded Partnerships (PTP) income (or loss) or (2) the Income Limitation, which is 20% of the taxpayer’s taxable income minus the net capital gains and qualified dividends recognized on the return.

Tomorrow’s blog posting is “How the TaxSlayer Pro program treats QBID”, and that posting will attempt to show how the different items that go into the calculation of the Qualified Business Income Deduction will flow in the tax program from the various schedules on the tax return to the worksheets required to calculate the QBID.