Qualified Business Income Deduction

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What Is The Qualified Business Income Deduction?

Before 2017, self-employed individuals who operated as pass-through entities paid lower taxes than corporate businesses. When the Tax Cuts and Jobs Act reduced the corporate tax rate to 21%, the IRS introduced the Qualified Business Income Deduction to please the 1099 workers. With this deduction, individuals could deduct 20% of their qualified business income and consequently pay less in taxes. As self-employed individuals have to pay income and self-employment taxes, the QBI deduction came as a blessing. However, this deduction is quite complex to understand and calculate. There are many eligibility rules (with sub-rules), and the math isn't always straightforward. The deduction is also set to end by the end of 2025, so it’s a good idea to understand the QBID and how you can take it. If this is your first time taking the deduction, it’s a good idea to get a CPA to help you avoid any mistakes. If you want to do it yourself, then keep on reading.
Key takeaways:
  • The Qualified Business Income Deduction allows eligible businesses and individuals to deduct 20% of their taxable income
  • This deduction only affects income taxes
  • The QBI deduction should be claimed on Form 8995

Table of contents

QBI deduction 101: How does it work?...Read more

Who can claim the QBI deduction?...Read more

2023 income limits for the QBI deduction...Read more

How to take the QBI deduction?...Read more

QBI deduction 101: How does it work?

Let’s start at the beginning. What is qualified business income? It is simply any taxable income earned by a business. Usually, the QBID is taken by entities with “pass-through” income. Pass-through entities do not pay corporate taxes. Instead, their income is taxed based on the owner’s personal tax rate. We’ll get into pass-through entities later, but most self-employed individuals choose to be taxed as pass-through entities to avoid paying corporate tax. If you use the QBID to reduce 20% of your taxable income, remember that it only lowers income taxes, not self-employment taxes. The Qualified Business Income Deduction can be claimed regardless of whether you take the standard deduction or itemize your deductions. Certain income limits also depend on your filing status, which will determine how much of the deduction you can claim.

Quick tip

Using a 1099 tax calculator to easily find business expense deductions to lower self-employment taxes.

Who can claim the QBI deduction?

There are a few types of entities and individuals who can claim the QBID. We mentioned earlier that pass-through entities can claim this deduction. This includes entities like: It is also important to mention that C Corps cannot claim the QBI deduction as they pay corporate income tax. If you own more than more pass-through entities, you can combine them to get a bigger deduction. Apart from pass-through entities, individuals with qualified dividends are also eligible for the QBI deduction. This can include income from a PTP (Publicly Traded Partnership) or dividends from a REIT (Real Estate Investment Trust). If you’re lucky enough to have both pass-through income and qualified dividends, you can actually take the deduction on both types of qualified business income. So, you would deduct 20% of your business income and 20% of your income from the dividends.
Who can claim the <span style="background: linear-gradient(101.76deg, #19ACA4 1.98%, #3563CD 100.59%);
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If you’re unsure how to navigate the deduction, you can use FlyFin. Expert CPAs will provide unlimited support with your taxes, and A.I. will easily find every business deduction you can claim to lower self-employment taxes. There are also certain types of income that are exempt from the QBID. These include:
  • Capital gains or losses and dividends
  • Interest income not correctly linked to a trade or business
  • Payments received for services outside of a partner role
  • W-2 income (if you also work a side hustle)
  • Guaranteed payments from a partnership
  • Reasonable compensation from an S corporation
  • Income from outside U.S. business activities
  • Commodities transactions
  • Foreign currency gains or losses
  • Qualified PTP income
  • Qualified REIT dividends
It's also important to remember that the 20% QBI deduction doesn't apply to funds invested in retirement plans like a 401(k) or SEP-IRA. If you contribute to a 401(k) or any other self-employed retirement account, the amount you contribute is tax-deductible. Claiming a retirement contribution tax deduction reduces your taxable income, which is good news. But, a lower taxable income means a lower QBI deduction. This means you have to make a choice between immediate and future savings. If you decide to forgo increasing your retirement savings in favor of boosting your current QBI deduction, you'll owe less tax to the IRS right now. The trade-off is missing out on the long-term advantages of 401(k) contributions. This decision is a personal one, so make sure you consider both the short-term and long-term financial benefits.

2023 income limits for the QBI deduction

So, you are a self-employed individual looking to take the QBID. If you’re a pass-through business, you’ve already ticked off one eligibility rule. Your taxable income will decide if you make it through the next. In 2023, single filers with a qualified business income under $182,100 can claim the full 20% deduction. The same applies to joint filers with income under $364,200. This is an increase from the 2022 QBID limits of $170,050 for single filers and $340,100 for joint filers. If your income is above these limits, you can still claim the deduction, but only partially. There is also a maximum income limit to claim the deduction. For single filers, it is $232,100, and for joint filers, it is $464,200. If your income is above the maximum limit, you can still claim a deduction if you aren’t part of an SSTB (Specific Service Trade or Business). In this type of business, an individual’s skillset is the main asset of the entity. Some examples of SSTBs are:
  • Lawyers
  • Consultants
  • Accountants
  • Athletes
  • Performers
  • Healthcare workers
  • Traders
  • Investment managers
In these cases, the QBI deduction cannot be claimed once the maximum income limit has been exceeded.
2023 income limits for the <span style="background: linear-gradient(101.76deg, #19ACA4 1.98%, #3563CD 100.59%);
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If you’re not part of a Specific Service Trade or Business, and you pay wages to your employees, this is how you’d calculate your deduction. Your deduction will be capped at the greater of 50% of your employee’s salary or 25% of their salary plus 2.5% of any property you can depreciate. This includes buildings, vehicles, equipment and computers. This is pretty complicated, so let’s look at an example. Say you’re a self-employed consultant with your own business. Your total business income before any deductions is $200,000 in 2023. This means you qualify for the Qualified Business Income Deduction (QBID). However, if your income is in the range where you can claim a partial deduction, you need to do some math. Let's say you also have $300,000 worth of business property and an employee that you pay $50,000 a year. So first, you calculate 50% of your employee’s wages.
  • 50% x $50,000 = $25,000
You now have to calculate the second comparison amount. 25% of your employee’s wages plus 2.5% of your property's worth
  • 25% x $50,000 = $12,500
  • 2.5% x $300,000 = $7,500
  • $12,500 + $7,500 = $20,000
So, your QBID will max out at $25,000 as it’s the greater of the two. We also mentioned earlier that REIT dividends and PTP income can get you an additional QBID. What we didn’t mention is that it’s not so simple. So, if you have dividends from qualified REITs or PTPs, you can grab a second deduction, up to 20% of that income, added to the initial QBI deduction. After calculating both deductions, you combine them. Then, the overall limit is 20% of your taxable income for the year (pre-QBI deduction), minus net capital gains, including qualified dividends taxed at capital gains rates. This keeps the 20% deduction from overlapping with income already taxed at lower capital gains rates. Let’s use another example for this. Say you’re a small business owner with an Etsy store who also invests in real estate. In 2023, you earned $120,000 from the store and received $10,000 in dividends from real estate investment trusts (REITs). You also gained $8,000 from selling stocks. The Qualified Business Income Deduction (QBID) is initially calculated at 20% of the business income, resulting in $24,000.
  • 20% x $120,000 = $24,000
You can also claim an additional QBID for the REIT dividends. Take an extra deduction of 20% of the dividends, which is $2,000.
  • 20% x $10,000 = $2,000
You add both the deductions ($24,000 + $2,000), giving you $26,000. After subtracting these deductions from your total income, your taxable income is $104,000.
  • ($120,000 + $10,000) - $26,000 = $104,000
Applying the QBID to the taxable income, you calculate a deduction of $20,800.
  • 20% x $104,000 = $20,800
However, you still have to account for your net capital gains. Since you got $8,000 from stock sales, this is deducted from the calculated QBID, bringing the final taxable income after QBID and capital gains adjustments to $12,800.
  • $20,800 - $8,000 = $12,800

How to take the QBI deduction?

Now, let’s talk about how to claim the QBI deduction.Form 8995 (Qualified Business Income Deduction Simplified Computation) is the main form you’ll need to do this is. If your income is above $182,100 as a single filer or above $364,000 as a joint filer, you’ll need to use Form 8995-A. Form 8995 (and Form 8995-A) has a detailed worksheet where you can enter your qualified business, REIT and PTP income to calculate your deduction amount. But first, you’ll need to fill out Schedule C. Once you find your taxable income after writing off your deductions, you should fill out Form 1040 to find your AGI (Adjusted Gross Income) and then start working on Form 8995. We should also mention that tax liabilities over $1,000 should be paid off by making quarterly tax payments, which an estimated tax calculator can help you do.
How to take the <span style="background: linear-gradient(101.76deg, #19ACA4 1.98%, #3563CD 100.59%);
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If this is all very confusing, you're not alone. The QBI deduction is a big bonus for eligible businesses, offering a nice tax perk. However, as you've seen from the explanations above, figuring out who can actually claim this deduction and then crunching the numbers can give you quite the brain workout. For small business owners, it's a smart move to keep an eye out for deductions and potential tax advantages. While getting familiar with the top tax breaks for small businesses is valuable, when it comes to calculating your QBI deduction, it's probably best to hand that task over to a CPA who knows what they’re doing.

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