Can I Claim the QBI Deduction for My Small Business?

The qualified business income (QBI) deduction was a centerpiece of the Tax Cuts and Jobs Act, which went into effect in 2018. Through 2025, the write-off is available to eligible individuals.

The QBI deduction can be up to 20% of:

• QBI earned from a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for federal income tax purposes, plus,
• QBI from a pass-through business entity, meaning a partnership, an LLC that’s treated as a partnership for federal income tax purposes or an S corporation.

Pass-through businesses report their federal income tax items to their owners, who then take them into account on their owner-level returns. The QBI deduction, when allowed, is then written off at the owner level, and it can potentially be a big tax-saver.

Deduction Basics

QBI means qualified income and gains from an eligible business reduced by related deductions and losses. According to the IRS, QBI from a business is reduced by:

1. The allocable deduction for a contribution to a self-employed retirement plan,

2. The allocable deduction for 50% of your self-employment tax bill, and

3. The allocable deduction for self-employed health insurance premiums.

Income from the business of being an employee doesn’t count as QBI. The same is true of guaranteed payments received by a partner or an LLC member treated as a partner for tax purposes for services rendered to a partnership or LLC (often called partner salaries). Salary collected by an S corporation shareholder-employee does not count as QBI, nor does salary collected by a C corporation shareholder-employee.

On your Form 1040, the QBI deduction doesn’t reduce adjusted gross income (AGI). In effect, it’s treated the same as an allowable itemized deduction.

Unfortunately, the QBI deduction also doesn’t reduce your net earnings from self-employment for purposes of the self-employment tax nor does it reduce your net investment income for purposes of the 3.8% net investment income tax (NIIT) that can hit higher-income individuals.

Deduction Limitations

At higher income levels, unfavorable QBI deduction limitations come into play.

For 2024, the limitations begin to phase in when taxable income (calculated before any QBI deduction) exceeds $191,950 ($383,900 if you’re a married joint filer). For 2024, the limitations are fully phased in once taxable income exceeds $241,950 ($483,900 for married joint filers).

For 2023, the limitation thresholds were $182,100 and $364,200, respectively. For 2023, the limitations were fully phased-in once taxable income exceeded $232,100 or $464,200, respectively.

If your income exceeds the applicable phased-in number, your QBI deduction is limited to the greater of: 1) your share of 50% of W-2 wages paid to employees during the tax year and properly allocable to QBI or 2) the sum of your share of 25% of such W-2 wages plus your share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.

The limitation based on the UBIA of qualified property is intended to benefit capital-intensive businesses like manufacturing or hotel operations. Qualified property means depreciable tangible property (including real estate) that’s owned by a qualified business and used by that business for the production of QBI. The UBIA of qualified property generally equals its original cost when it was first put to use in your business.

Finally, your QBI deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and before any net capital gain amount (net long-term capital gains in excess of net short-term capital losses plus qualified dividends).

Unfavorable Rules for Specified Service Trades or Businesses

If your operation is a specified service trade or business (SSTB), QBI deductions begin to be phased out when your taxable income (calculated before any QBI deduction) exceeds the applicable threshold.

What’s a Specified Service Trade or Business (SSTB)?

In general, an SSTB is any trade or business involving the performance of services in one or more of the following fields:

• Health, law, accounting, and actuarial science (but not architecture and engineering firms),
• Consulting,
• Financial, brokerage, investing and investment management services,
• Trading,
• Dealing in securities, partnership interests or commodities, and
• Athletics and performing arts.

Concern about one SSTB

There’s another SSTB, which came with some concerns after the law authorizing the QBI deduction was enacted. It involves any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.

Before the IRS issued regulations, there was concern that the above definition could snare unsuspecting businesses like local restaurants with well-known chefs. Thankfully, the regulations limit the definition to trades or businesses that meet one or more of the following descriptions:

• A person receives fees, compensation, or other income for endorsing products or services.
• It receives fees, licensing income compensation, or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbol associated with that individual’s identity, and
• It receives fees, compensation, or other income for appearances at an event or on radio, television, or another media platform.

For 2024, the phase-out begins when your taxable income (calculated before any QBI deduction) exceeds $191,950 ($383,900 if you’re a married joint filer). For 2024, phase-out is complete if your taxable income exceeds $241,950 ($483,900 for married joint filers).

For 2023, the phase-out begins when your taxable income exceeds $182,100 and $364,200, respectively. For 2023, phase-out is complete if your taxable income exceeds $232,100 or $464,200, respectively.

Bottom Line: If your taxable income exceeds the applicable complete phase-out number, you’re not allowed to claim any QBI deduction based on income from any SSTB.

Aggregating Businesses

Aggregating businesses can allow an individual with taxable income high enough to be affected by the limitations based on W-2 wages and the UBIA of qualified property to claim a bigger QBI deduction than if the businesses were considered separately.

For example, say you are a high-income individual who owns an interest in one business with lots of QBI but little or no W-2 wages and an interest in a second business with minimal QBI but lots of W-2 wages. Aggregating the two businesses can result in a healthy QBI deduction while keeping them separate could result in a lower deduction or maybe no deduction. However, you must pass tests set forth in IRS regulations to be allowed to aggregate businesses.

Key Point: You can’t aggregate a SSTB with any other business, including another SSTB.

Scheduled to Disappear

As the tax law reads right now, the QBI deduction is essentially a use-it-or-lose-it deal, because it’s scheduled to expire after 2025. Congress could extend it, but you shouldn’t plan on that happening. The QBI deduction rules are explained in detail in IRS regulations that are lengthy and complex.  Your tax professional can advise you on how to get the best QBI deduction results and the best overall federal tax results in your specific circumstances.

Copyright 2024

This article appeared in Walz Group’s January 29, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.