What Is The Qualified Business Income Deduction?

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.

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

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.