As part of the 2017 tax overhaul, there is a new 20% deduction on Qualified Business Income (“QBI”) available to self-employed workers with pass-through taxation (LLC, S-corp, sole proprietorships; basically anything that’s not a C-corp) in the following income brackets:
- Single Filers – Threshold is $164,900, with a phase-down from there to $214,900
- Married Filing Jointly – Threshold is $329,800 with a phase-down from there to $429,800
The deduction has different income phase-out levels for businesses that are “specified service trade or business” (“SSTB”). SSTB’s are defined as service-based businesses other than engineering or architecture, that depend on the reputation or skill of its employees or owners. Examples include lawyers, doctors, consultants, professional athletes, accountants, financial services, investment services, and more. If you’re still not sure if your business is an SSTB or not, there is more information on the IRS website (here).
Be sure to ask your tax advisor if you’re eligible for this 199A tax break, as the 20% deduction could provide significant savings. For example, if you had $100k of qualified business income this would give you an additional $20k of deductions, which at a 24% tax rate results in $4,800 of savings.
The one thing to note is that the 199A deduction cannot exceed 20% of your taxable income. Taxable income refers to your income before the QBI is applied. For example, if you earned $100k of income on your Schedule C, The 199A deduction would be equal to 20% of that $100k, or $20k. However, if you and your spouse took a $24k standard deduction, then your taxable income is $100k – $24k = $76k. So your 20% deduction would be capped at 20% x $76k = $15,200. That being said, if your spouse earned W2 income of $50k, then your taxable income = $50k + $100k – $24k (standard deduction) = $126k, and you can take the full 20% deduction on your $100k of qualified business income.
You’ll claim the deduction on Form 1040 Line 13. You’ll have to fill our Form 8995 or Form 8995-A as a supplement. Given all the nuances of the law, below is a useful checklist to use:
- What is your taxable income for the year? If you’re below the threshold of $164,900 ($329,800 for joint filers), then no matter what your business is, you can take the full 20% deduction.
- If your business is above the threshold, and you’re not an SSTB, then:
- For income between $164,900 and $214,900 for single filers ($329,800 and $429,800 for joint filers) you can still claim the full 20% deduction.
- For income above $214,900 for single filers and $429,800 for joint filers, you are subject W-2 wage limitation below.
- If your business is above the threshold, you are an SSTB, then:
- If your income is above $214,900 (or $429,800 for joint filers) you get no 199A deduction.
- For income between $164,900 and $214,900 for single filers ($329,800 and $429,800 for joint filers) you are subject to the W-2 wage limitation below.
- For the W-2 wage limitation, you’ll still calculate 20% of your QBI, but then potentially limit that further, to the greater of (a) 50% of your share of W-2 wages paid by the business (if you’re a sole-proprietor or a business with no partners, then it’s just 50% of the W-2 wages paid), or (b) 25% of your share of W-2 wages paid by the business, plus 2.5% of your business share of qualified property.