The Tax Cuts and Jobs Act (TCJA) provided the biggest tax reform in over 30 years. It affects taxes all over the board, but perhaps the biggest change will be felt by businesses. Corporate tax rates for large businesses were reduced from 35% to 21%, which is an immediate 14% bump to the bottom line for those businesses. However, small business owners have some possible tax savings as well. For pass-through businesses like sole proprietors, S-corps, and partnerships, owners may qualify for a 20% deduction of their business income. This comes in the form of a deduction for Qualified Business Income (QBI).
What is the QBI Deduction?
Eligible taxpayers may be eligible for a deduction of up to 20% of Qualified Business Income. This means if your business has $100,000 of QBI, you will only pay tax on $80,000 if your business is eligible and you’re within certain income thresholds.
What is Qualified Business Income (QBI)?
QBI is the net amount of business income, gain, deductions, and losses of any qualified trade or business in the U.S. For most businesses, it is essentially the net income.
Is my business eligible for the QBI Deduction?
At a high level, this deduction is designed to benefit employers that hire people to grow the US economy, not necessarily to provide great tax savings to those that earn high incomes as a result of their own labor and expertise. If a business is classified as a Specified Service Trade or Business (SSTB) it can’t claim the deduction if income is too high. Doctors, dentists, attorneys, accountants, financial advisors, and consultants fall into this category. The IRS recently released guidance1 around which specific types of business are SSTBs and may therefore be limited on the QBI Deduction.
I am a SSTB – at what income does this deduction phase out?
For married couples filing a joint return, the QBI deduction begins to phase out at a taxable income of $315,000 in 2018. For all other taxpayers the phase out begins at $157,500. If taxable income exceeds $415,000 for joint filers (or $207,500 for other filers), the deduction is fully eliminated for businesses classified as a SSTB.
Therefore, as long as your taxable income is below $315,000 (assuming you file jointly), you automatically qualify for the full QBI deduction and will experience awesome tax savings. If your taxable income is over that threshold you’ll need to determine if the business is a SSTB to see if you qualify for the deduction.
I am an employee – do I qualify for the QBI Deduction?
No. Those only performing services as an employee (and therefore only receiving W-2 wages) are excluded from the QBI deduction.
The QBI deduction is an awesome addition to the new tax law that can save a huge amount of taxes for those that qualify. It also creates unique tax planning opportunities for those in the phase-out range. If you own a small business, it’s a good idea to reach out to a qualified accountant and do some proactive planning around this new deduction. If you’re able to take advantage of tax-reduction strategies2 and lower your taxable income below the QBI thresholds you’ll save a substantial amount in taxes.
These are the opinions of Dan Funderburk and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.
Dan Funderburk is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.
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