Qualified Business Income Deduction
(for self-employed & business owners)
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Qualified Business Income Deduction: Are You Eligible and Should You Take It?
How much is your QBI deduction?
With costs rising across the globe, it's becoming more important than ever for business owners to find ways to save on taxes. One thing business owners in America can rely on to save on their expenses is by writing off their business expenses and taking deductions. If you own a business, you might qualify for a specific deduction simply by being a business owner.
The qualified business income (QBI) deduction is a tax break offered to small business owners and self-employed individuals. It offers the possibility of a 20% tax deduction, which can make a big difference in a business' bottom line. As with anything tax-related, there are rules and regulations around this deduction, and you'll need to make sure you meet all the requirements to take advantage of it.
Key takeaways
- The qualified business income deduction allows business owners to write off 20% of their taxable income
- Most business entities qualify for the deduction
- Specified trade or business workers may have certain limitations imposed on them when taking the QBI deduction
What is the QBI deduction?
This is a deduction that gives small business owners and self-employed individuals a break on their taxes by letting them write off up to 20% of their taxable pass-through entity reporting income. What is a pass-through entity? Unless your business is classified as a C corporation, it's probably considered a pass-through business. C Corps are subject to paying corporate taxes, but all other business entities have their income passed through to the owners, who are taxed at an individual income level. QBI is just earned income that's taxable. The 2017 Tax Cuts and Jobs Act created the QBI deduction to lower the corporate tax rate to 21%. Previously, the corporate tax rate was much higher, at 35%. Workers with pass-through income have always been at an advantage since they didn't need to worry about corporate tax rates. Business owners felt that lowering tax rates for corporations, but not for them, was unfair, and many people were angry with the IRS. To help ease the frustration, the IRS came up with the QBI deduction.
📝 Who qualifies for the QBI deduction?
Any business owner with pass-through income is eligible for the deduction, including:
Partnerships: Form 1099-NEC (Non-employee Compensation) is meant for freelancers or independent contractors. The form details the income received for services you performed for someone who isn't your employer.
Sole proprietors: a business owner who is the only employee and makes all the decisions on behalf of the business.
Limited liability companies (LLCs): a combination of a sole proprietorship and a partnership that acts like a corporation and offers the employer legal protection.
S corporations: a company whose profits, losses, credits and deductions are reported on the owner's personal income tax return.
If your business falls into the category of a specified trade or business (SSTB), your qualified business income deduction may have limitations, or you might not have any eligibility once your taxable income reaches a certain level. More on that later. SSTB workers are part of the service industry where the business relies on the skills of the owners or employees. SSTB is a business designation recognized by the IRS.
Not every profession falls into the category of SSTB and the list is set by the IRS. For example, If you work as a physical therapist or nurse practitioner, you would be considered an SSTB worker. But if you're a personal trainer or health coach, you would not be considered one. Working as a portfolio manager or financial advisor counts, but working as a banker doesn't.
Workers not eligible for the SSTB designation:
- Teachers
- Architects
- Engineers
- Bank tellers
- Beauty salon workers
- Real estate agents
- Transportation workers
- Landscapers
- Gym owners
Quick tip
What's considered qualified business income?
Basically, QBI is your share of business profits. In any trade or business, it's the total amount of gain, income or loss. The income or deductions must be related to your business income, even if it's not reported on your business income tax return.
QBI limitations
The IRS has criteria for what counts as business income, and there are some QBI limitations. Certain business income can't be counted towards the deduction.
Specified service or trade or business workers
If you fall into the SSTB worker category, you probably want to know whether you will get the full 20% QBI deduction, a partial deduction, or unfortunately no deduction at all. This all depends on your total taxable income, which is your total income before the QBI deduction, including dividends, assets, rental income, side gig income and income from a spouse, if you're filing jointly.
Usually, this is your adjusted gross income found on Form 1040, and the qualified income deduction doesn't reduce your self-employment tax. Only business deductions can help lower this. The qualified income deduction for SSTB workers depends on filing status and income level. Once you've reached the income threshold, you won't be eligible for the deduction.
2022 taxable limits:
Filing status
Taxable income
Available QBI deduction
Single
< $170,050
20%
Single
$170,050-$220,050
Partial
Married filing jointly
< $340,100
20%
Married filing jointly
$340,100-$440,100
Partial
Married filing jointly
> $440,100
0
2023 taxable limits:
Filing status
Taxable income
Available QBI deduction
Single
< $182,100
20%
Single
$182,100-$232,100
Partial
Single
> $232,100
0
Married filing jointly
< $364,200
20%
Married filing jointly
$364,200-$464,200
Partial
Married filing jointly
> $464,200
0
Taxable income above the threshold
If you have taxable income above the limits for single filers ($220,050) or people who are married filing jointly ($440,100), your deduction will be limited to whichever of these is greater:
- 50% of your share of W-2 wages paid by the business, or
- 25% of your share of W-2 wages, plus 2.5% of qualified property
REIT dividends and PTP income
Besides business owners, anyone with qualifying dividends from a real estate investment trust (REIT) or publicly traded partnership (PTP) income can also claim the QBI. PTP income includes businesses relating to natural resources, like petroleum. REIT dividends need to be held for 45 days, which doesn't include any capital gains.
The qualified income deduction is typically the smaller amount of the following:
- 20% of your qualified business income, plus 20% of PTP and REIT dividends
- 20% of your income that's taxable, minus any net from capital gains
The workings of the QBI deduction
When it comes to deductions, you have two options: the standard deduction or itemized deductions. With the QBI deduction, it doesn't matter which option you choose, as both are eligible for the deduction, making the decision much easier for you.
Things can be a bit complicated when it comes to calculating your qualified business income. Breaking it down into steps can help the process be a bit more manageable.
- Figure out whether your business is an SSTB business. The IRS has an extensive list to help you with this.
- Calculate your taxable income for the tax year. You qualify for the full 20% deduction if it's below the threshold.
- If you are an SSTB business, and your taxable income is over $220,050 (as a single filer), you've maxed out the threshold and aren't eligible for the refund. You can calculate the partial deduction if it's between $170,050-$220,050.
- Any SSTB business with phase-out range income needs to calculate the deduction by taking 20% of qualifying business income and one of the limitations mentioned earlier as above the threshold.
For example, let's say you're a single filer and own your own gym. Your annual gross income is $150,000. Your income is below the single filing threshold of $170,050 and therefore you'd qualify for the deduction.
When it comes to taxes, there is always a lot to track and manage. But with the help of FlyFin, managing your income and filing taxes is easier than it's ever been. All your expenses and income are in one place, so there's no need to keep receipts or spreadsheets. A.I. will find every possible deduction, saving you time and money. An expert CPA team is available in the app to help you pay income tax and file your tax return.