Do You Qualify for the QBI Deduction?
February 27, 2019 by Brook R. Hall, CPA
One of the most important changes from the Tax Cuts and Jobs Act (TCJA) is the new qualified business income (QBI) deduction for pass-through entities. Section 199A created under the TCJA allows a deduction up to 20% of income to a non-corporate taxpayer, including a trust or estate, who has qualified business income from partnerships, S corporations, or sole proprietorships. The final regulations as corrected, published in the Federal Register on February 8, 2019, weigh in at 247 pages.
The TCJA provided significant corporate tax relief, reducing the graduated rate structure of up to 35% with a flat corporate tax rate of 21%. The new qualified business income deduction was enacted to provide similar tax relief to small businesses that do not operate as C corporations.
Pass-through entities such as S corporations and partnerships do not claim the deduction themselves. Each shareholder or partner’s share of qualified business income is reported on Schedule K-1 so that each taxpayer may determine their QBI deduction. Income from C Corporations is not eligible for the deduction, nor is income that is generated by providing services as an employee.
The QBI deduction is subject to limitations for taxpayers with overall taxable income that exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers. These limitations include:
- The type of trade or business
- The amount of W-2 wages paid by the qualified trade or business
- The unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business
If a taxpayer’s income is above the $315,000/$157,500 thresholds, the deduction may be limited based on whether the business falls into one of the specified service trade or business (SSTB) classifications, including:
- Health services
- Legal services
- Accounting services
- Actuarial science
- Performing arts
- Financial services
- Investing and investment management
- Trading or brokerage
- Dealing in certain assets or securities
- Any trade or business where the principal asset is the reputation or skill or one or more of its employees
Engineering and architecture services, while not defined in the regulations, are specifically excluded from consulting services. The SSTB limitation is phased in for joint filers with taxable income between $315,000 and $415,000, and all other filers with taxable income between $157,500 and $207,500. For those with taxable income above the $415,000/$207,500 threshold, no deduction is allowed for SSTB-related income.
Even if the qualified business income is not from a specified service trade or business, certain factors can limit the deduction for those above the $415,000/$207,500 threshold. Above those taxable income amounts, the QBI deduction is the lesser of:
- 20% of qualified business income
- The greater of:
- 50% of W-2 wages for the trade or business
- 25% of W-2 wages plus 2.5% of the UBIA of qualified property
In other words, if one or both of the 50% of W-2 wages and 25% of W-2 wages + 2.5% of UBIA of qualified property exceeds 20% of qualified business income, then the full deduction applies. If both are less than 20% of qualified business income, then the deduction is limited to the amount of the two that is largest.
The threshold amounts for tax year 2018 ($315,000/$157,500) will increase to $321,400 for joint returns, $160,725 for married taxpayers filing separately, and $160,700 for single and head of household returns in 2019. The 2018 phase-out amounts ($415,000/$207,500) will increase to $421,400 for joint filers, $210,725 for married taxpayers filing separately, and $210,700 for single and head of household returns in 2019. These amounts will continue to be adjusted for inflation by the IRS in future years.
Eligible taxpayers may also be entitled to a deduction of up to 20% of dividends from a qualified real estate investment trust (REIT) and income from a qualified publicly traded partnership (PTP). This portion of the 199A deduction is not subject to limitations such as W-2 wages or the UBIA of qualified property.
Real estate rental activities may be considered a qualified trade or business depending upon the type of rental property, the number of properties rented, the involvement of the owner or owner’s agent in day-to-day management, ancillary services provided, and the type of leasing or rental arrangements that are managed. Contact Gordon Advisors for more information, including how the rule impacts rentals that do not otherwise meet the trade or business requirement, including triple net leases.
The availability of the QBI Deduction provides many tax planning opportunities. Since it is a passthrough deduction, the savings occur at the partner/shareholder level. We can plan to maximize the QBI deduction, by employing various strategies, which may support retaining capital in the pass-through entity for future growth or business needs. The rules under code section 199A are voluminous and have many complexities regarding computing the deduction, including determining W-2 wages, the UBIA of qualified property, REIT dividends and PTP income, aggregation rules for related entities, and anti-abuse provisions. Consult a qualified tax specialist at Gordon Advisors to evaluate your specific situation.