One of the most prominent tax deductions for this 2018 tax year is the 20% Qualified Business Income (QBI) tax deduction, also known as Sec 199A of the IRS tax code. Effective for tax years beginning after December 31, 2017 and before January 1, 2026 taxpayers that are not corporations are entitled to a 20% deduction on “qualified business income” earned in a “qualified trade or business.”

How much is the deduction?

The QBI tax deduction is 20%. However, if you have taxable income over $315,000 for the year (if married, $157,500 if single) then the deduction becomes limited. The limits are based on the taxable income, type of business, wages paid and unadjusted basis of certain property used by the business. If you are over the 315,000 threshold your deduction will become limited based on the following:

• Whether your business is a Specified Service Trade or Business (SSTB)
(explained later);
• W-2 wages paid by the business; and
• Unadjusted basis (UBIA) of certain property used by the business.

Who can claim the deduction?

The new deduction generally applies to owners of pass-through entities such as:

• Sole proprietorships
• S-corporations
• Partners in a domestic partnership
• Rental properties

Owners with a pass-through entity (listed above) who have a qualified trade or business with qualified business income can claim the QBI deduction.

Section 199A defines a qualified trade or business as any trade or business that is NOT:

• The trade or business of performing services as an employee, and
• A specified service trade or business.

Section 199A(d)(2) defines a specified service trade or business (SSTB)as “any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.”

Section 199A(d)(2)(B) also includes performance of services that consist of investing and investing management, trading, or dealing in securities, partnership interests, or commodities as a specified service business.

This doesn’t mean that the specified service businesses cannot claim the deduction, it just means that they have their own special rules. (Seen Later)

Qualified business income is defined as the net amount of items of income, gain, deduction, and loss with respect to any qualified business of the taxpayer. QBI is determined separately for each qualified business. Qualified business income does not include, certain investment-related income, including the following:

• Short-term and long-term capital gains and losses
• Dividends
• Interest income no properly allocable to a trade or business
• Reasonable compensation payments to a taxpayer for services rendered to
a qualified business
• Guaranteed payments to a partner for services rendered to a business
• Sec. 707(a) payment to a partner for services rendered to the business

How to calculate the deduction for Specified Service Trade or Business?

If your business falls within the SSTB group, and your taxable income is below $315,000 for the year (if married, $157,500 if single) the calculation is as follows:

1. Calculate your business’s Qualified Business Income. This is net income
minus salary or payments made to owners for services.

2. Multiply QBI by 20%

If your business falls within the SSTB group, and your taxable income is between $315,000 – $415,000 (Married) $157,500 – $207,500 (Single) the calculation is as follows:

1. Calculate your business’s Qualified Business Income. This is net income
minus salary or payments made to owners for services.

2. Calculate ratio of income over the threshold of $157,500 for single
taxpayers and $315,000 for Married Filing Jointly taxpayers.

3. QBI times 20% times ratio over threshold.

4. Determine the greater of:
a. 50 % of includible W-2 wages time ratio over threshold; or
b. The sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of all
“qualified property” in the business times ratio over threshold.

5. Your deduction is the lesser of step 3 or 4.

If your business falls within the SSTB group, and your taxable income is above $415,000 (Married) $207,500 (Single) than you do not qualify for the QBI deduction.

How to calculate the deduction for Non SSTB?

If your business falls is not an SSTB, and your taxable income is below $315,000 for the year (if married, $157,500 if single) the calculation is as follows:

1. Calculate your business’s Qualified Business Income. This is net income
minus salary or payments made to owners for services.

2. Multiply QBI by 20%

If your business is not an SSTB, and your taxable income is between $315,000 – $415,000 (Married) $157,500 – $207,500 (Single) the calculation is as follows:

1. Calculate your business’s Qualified Business Income. This is net income
minus salary or payments made to owners for services.

2. Multiply QBI by 20%

3. Determine the greater of:
a. 50 % of includible W-2 wages; or
b. The sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of
all “qualified property” in the business.

4. Take the difference between step 2 and 3.

5. Calculate ratio of income over the threshold of $157,500 for single
taxpayers and $315,000 for Married Filing Jointly taxpayers.

6. Multiply the ratio found in step 5 by amount on step 4.

7. Your deduction is the amount in step 2 reduced by amount on step 6.

If your business is not an SSTB, and your taxable income is above $415,000 (Married) $207,500 (Single) the calculation is as follows:

1. Calculate your business’s Qualified Business Income. This is net income
minus salary or payments made to owners for services.

2. Multiply QBI by 20%.

3. Determine the greater of:
a. 50 % of includible W-2 wages; or
b. The sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of
all “qualified property” in the business.

4. Your deduction is the lesser of step 2 or 3.

The qualified business income deduction is a below the line deduction which does not have affect the adjusted gross income. This deduction cannot be taken on loss years, and if the QBI deduction is negative than the amount will be treated as a loss in the following year.

Section 199A QBI deduction is strictly a federal income tax deduction not to be used for payroll. This deduction will end 2026 if congress does not act to extend.

As this deduction is still very new and further guidance will come out by the IRS, this serves to give a general idea of how the Qualified business income deduction works. This deduction is very complex and has a lot very specific rules which is why this should not be used as reference when taking the Sec 199A deduction.