Maximize Your Tax Savings with Qualified Business Income Deduction (QBID)

Small business owners as well as self-employed individuals are always on the lookout to minimize their tax liability. Whether it is through eligible tax credits, deductions, or strategic financial planning, every opportunity to save matters. One significant provision that has been helping small business owners and self-employed individuals save more on taxes is the Qualified Business Income Deduction (QBID).

Also known as the Section 199A deduction, QBID was Introduced as part of the Tax Cuts and Jobs Act (TCJA) of 2017. It allows eligible taxpayers to deduct up to 20% of their qualified business income (QBI) and enhance their financial efficiency.

However, the rules surrounding QBID are complex and it is important to carefully understand them. Let’s see what QBID is and how you can use it to maximize your tax savings.

What is a Qualified Business Income Deduction?

QBID is a federal tax deduction that provides tax benefits to self-employed individuals and certain pass-through businesses that are earning income from qualified businesses. Unlike deductions for operating expenses, QBID is applied at the personal income tax level. It reduces 20% of their qualified business income (QBI) without requiring additional out-of-pocket expenses.

Income from a (qualified) trade carried out in the United States is considered qualified business income. It comprises earnings from S-corporations, partnerships, sole proprietorships, and some trusts and estates. However, C corporations and several forms of foreign income are not eligible for QBID.

Who Qualifies for QBID?

To claim QBID, you must meet the eligibility criteria. This includes:

1. Income Type: The deduction applies to qualified business income (QBI) only. It excludes:

• Capital gains and losses
• Dividends
• Interest income (unless business-related)
• Foreign Income
• Employee wages

2. Business Structure: Only pass-through entities qualify for QBID. These include:

• Sole proprietorships
• Partnerships
• S corporations
• LLCs taxed as partnerships or S corporations

As mentioned above, C corporations and entities taxed as corporations do not qualify for QBID.

3. Taxable Income Thresholds: Taxpayers having taxable income below a certain threshold can claim QBID without limitations. For 2024, the taxable income thresholds are:

• Married filing jointly – $383,900
• All other filing statuses – $191,950

Taxpayers below these thresholds can claim the full deduction. Those above these amounts face limitations based on:

• W-2 wages paid by the business.
• The unadjusted basis of qualified property.
• The type of business (Specified Service Trade or Business, or SSTB).

4. Specified Service Trades or Businesses (SSTBs): SSTBs include professions where the principal asset is the reputation or skill of employees or owners. Examples are:

• Health services
• Law
• Accounting
• Consulting
• Financial services
• Performing arts

Special Rules and Limitations for SSTBs

For SSTBs, QBID is phased out for taxpayers with taxable income above the thresholds. Planning to stay below these limits or re-evaluating business structure can mitigate these limitations.

How to Calculate Qualified Business Income Deduction?

The QBID is generally 20% of Qualified Business Income (QBI). However, this straightforward calculation applies if taxable income is below the thresholds.

If taxable income exceeds the thresholds, the deduction is limited to the lessor of :

• 20% of QBI
• Greater of:
  • 50% of W-2 wages paid by the business, or
  • 25% of W-2 wages + 2.5% of the unadjusted basis of qualified property.

For SSTBs, the deduction phases out completely at certain income levels:

• $241,950 for single filers.
• $483,900 for married filing jointly.

To calculate QBID:

1. Determine Qualified Business Income (QBI): Calculate the net income or loss from eligible qualified trades or businesses during the tax year. This includes amounts reported on
   • Schedule C for sole proprietors,
   • Schedule K-1 for partnerships,
   • Share of business income, excluding wages paid to the owner for S corp, and
   • Income from qualified REITs or PTPs.

2. Use the Deduction Percentage: Up to 20% of a taxpayer’s QBI may be written off. Taxable income (excluding capital gains) or QBI, whichever is lower, is the basis for the deduction.
3. Use the Deduction Percentage: Up to 20% of a taxpayer’s QBI may be written off. Taxable income (excluding capital gains) or QBI, whichever is lower, is the basis for the deduction.
4. Take Limitations and Phase-Outs into Account: W-2 wages, the type of business, and computations pertaining to real estate may restrict the qualified business income tax deduction if your income exceeds the specified thresholds. Speak with a qualified tax specialist to learn more about your unique circumstances.to understand your specific situation.
5. Claim the Deduction: Fill Form 8995 or Form 8995-A to claim the qualified income business deduction, and attach it to Form 1040.

Understanding QBID with Examples

Example 1: Basic Qualified Business Income Tax Deduction

John owns a sole proprietorship and earns $120,000 in QBI. He is a single filer and his taxable income is below the threshold.

• Deduction = 20% × $120,000 = $24,000

Example 2: Income Above the Threshold

Mary owns an LLC. She earns $500,000 (married filing jointly). Her business pays $150,000 in W-2 wages and has $500,000 in qualified property. Here’s how her deduction for qualified business income will be calculated:

1. Apply the Income Threshold:
   • Income threshold for married filing jointly (for 2024): $383,900.
   • Since Mary’s taxable income ($500,000) exceeds the threshold, we need to apply the W-2 wage and qualified property limitations.
2. Calculate the Potential QBID:
   • The basic QBID before limitations is 20% of QBI.
   • Potential QBID = 0.20 × $500,000 = $100,000 {Potential QBID = 0.20 times $500,000 = $100,000}
3. Apply the W-2 Wage Limitation:
   • The deduction is limited to the lesser of:
     • 20% of QBI or
     • The greater of:
       • 50% of W-2 wages paid, or
       • 25% of W-2 wages paid plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.
4. Calculating the W-2 Wage Limitation:
   • 50% of W-2 wages: 0.50 × $150,000 = $75,0000.50
   • 25% of W-2 wages plus 2.5% of UBIA of qualified property:

0.25 × $150,000 + 0.025 × $500,0000 = 37,500 + $12,500 = $50,000

5. Determine the Greater Value for W-2 Wage Limitation:
   • The greater of $75,000 and $50,000 is $75,000.
6. Final QBID Calculation:
   • The deduction is limited to the lesser of the potential QBID ($100,000) and the W-2 wage limitation ($75,000).

Hence, Mary’s QBID: $75,000

Example 3: SSTB with High Income

David, a lawyer, earns $600,000 (married filing jointly). In this case, David does not qualify for QBID as his income exceeds $514,200.

Advantages of QBID

• Tax Savings: QBID significantly lowers taxable income without the need of further deductions.
• Promotes the Growth of Small Businesses: By offering financial relief, the deduction enables companies to reinvest in their operations.
• Ease of Application: People with incomes below the levels can apply for QBID without having to perform complicated computations.

Limitations of QBID

1. Complicated Regulations for High Income: Taxpayers who earn more than the thresholds are subject to restrictions and exclusions, particularly for SSTBs.
2. Excluded Income: The potential deduction is decreased by non-QBI income, such as dividends and capital gains, which are not eligible.
3. Temporary Provision: QBID is a temporary deduction. Unless Congress extends it, the QBID will stop on December 31, 2025.

Tips for Maximizing the QBID

Here are some the ways to maximize the benefits of the QBID:

1. Adjust income and expenses to maximize QBI. Consider deferring income or maximizing deductible expenses to increase tax savings.
2. Determine if your current business structure allows you to fully utilize QBID. To determine the most tax-efficient entity type for your business, consult a tax professional.
3. Reduce taxable income by increasing your retirement contributions.
4. Assess different tax planning techniques to optimize QBID benefits and reduce total obligations.

The Final Words

QBID is an excellent tax benefit for small businesses and self-employed individuals. However, its rules and limitations require careful navigation. That’s why it’s better to seek professional tax guidance to maximize this deduction and reduce your tax burden.

If you need expert assistance with QBID or other tax matters, consult tax professionals at KnowVisory. We can help you evaluate your individual tax situation to ensure compliance and maximize tax savings.