Recent tax law changes have affected tax reporting for pass-through income. Commonly used by smaller businesses, pass-through income is taxed at standard individual income tax rates. However, many smaller businesses can deduct up to 20% of their pass-through income resulting in a lowered overall tax rate as long as it relates to qualified business income, or QBI. Such small business types include sole proprietorships, LLCs, S-Corps, and Partnerships.
About the Deduction
The QBI deduction is a ‘Below the Line” deduction, meaning it is deducted on your individual tax return after your adjusted gross income deductions. Such AGI adjustments include personal deductions and standard or itemized deductions. What is notable is the fact that the 20% QBI deduction does not count as an itemized deduction. What this means is you can take a standard deduction and still claim the QBI deduction.
Restrictions
Naturally, you cannot just claim 20% of your business income as an automatic deduction as there are limits on what can be claimed. These restrictions can vary depending on the income reported on your individual tax return and the type of business.
- Income Restrictions: to take the full 20% QBI deduction your personal income must not exceed $157,500 if filing single or $315,000 if filing as married. If your personal income falls below this level, then you can take the 20% pass-through deduction as listed and as claimable. However, if you exceed the income limitations, then you can take a LESSER credit of either 20% of your business’s income or 50% of the total wages paid to employees or 25% of wages, plus 2.5% of depreciable assets.
- Service Industries: the QBI deduction has restrictions for service-based industries as defined by the IRS such as law, health, accounting, athletics, and other such classified professions. If your personal income is less than the above listed $157,500 or $315,000 income thresholds, then the deduction is fully deductible. Once your earnings exceed $207,500 as an individual or $415,000 for filling married, the deduction is disallowed entirely. If your income falls between these ranges, then you receive part of the QBI deduction but not the full 20%.
| Specified service income and W-2 wage/basis limitations | ||
| Trade or business is not a specified service | Trade or business is a specified service | |
| Taxable income less than or equal to $157,500 (single), $315,000 (joint) | W-2 wage/basis limitations do not apply | W-2 wage/basis limitations do not apply; specified service income is eligible |
| Taxable income greater than$157,500 (single), $315,000 (joint) but less than $207,500 (single), $415,000 (joint) | W-2 wage/basis limitations are phased in over the $50,000 to $100,000 range | “Applicable percentage” of specified service income is eligible; AND W-2 wage/basis limitations are phased in over the $50,000 to $100,000 range |
| Taxable income greater than$207,500 (single), $415,000 (joint) | W-2 wage/basis limitations apply in full | Specified service income not eligible |
Final Considerations
As this is a new tax law for the 2018 filling year, further clarification is being made by the IRS and grey areas more clearly defined. Always consult the qualified and experienced accounting professionals at Fricke & Associates, LLC concerning your business’s taxes and proper credit calculations