Business Owners Can Now Claim The Qualified Business Income Deduction
Congress passed major tax reform legislation in the Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017. This law affects both individuals and businesses and most of its provisions take effect in 2018.
One major provision of TCJA that affects many business owners is the qualified business income deduction. The new deduction is also known as the pass-through deduction and the 20% deduction.
While net income from eligible businesses is taxed at individual rates, which can be as high as 37% in 2018, the TCJA provides an individual deduction of up to 20% of the business net income from a trade or business reported on a Schedule C, E or F. The deduction may be limited depending on the individual’s taxable income or type of business activity.
Who Can Claim the Qualified Business Income Deduction?
The qualified business income deduction potentially applies to any business operated as a sole proprietorship, a partnership, or an S corporation, as well as to some trusts and estates. C corporations are not eligible for the deduction.)
The deduction is available to eligible taxpayers, whether they itemize their deductions or take a standard deduction.
There are limitations to the qualified business income deduction. They include:
- Type of trade or business – certain service businesses face steep phaseouts
- 20% taxable income limit – the deduction can’t exceed 20% of taxable income minus net capital gain
- Wage and property limit – For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction is subject to limitations based on the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis of depreciable assets
What Qualifies as Business Income?
The deduction applies to the following qualified income:
- Business income from the sale of goods or services
- Publicly Traded Partnership income
- Real estate investment trust dividends
When Can You Claim the Qualified Business Income Deduction?
Eligible taxpayers can claim the deduction on their 2018 federal income tax return they file in 2019. This is the first time the deduction is available. The deduction can be claimed directly on Form 1040.
More Facts About the Qualified Business Income Deduction
The deduction is generally equal to the lesser of these two amounts:
- 20% of qualified business income plus 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income
- 20% of taxable income computed before the qualified business income deduction minus net capital gain
For example, a freelancer with net business income of $80,000 (and no other income) can deduct the lesser of:
20% of net business income
20% of taxable income
If the freelancer uses the Single filing status and claims the $12,000 standard deduction, the freelancer can deduct $13,600 from taxable income [i.e. 20% of ($80,000 – $12,000 standard deduction)].
As a result, the freelancer will only pay tax on $48,000 of income.
The new qualified business income deduction is one of many changes to the tax code for the 2018 tax year. Changes to itemized deductions, bonus depreciation, expensing, credits, and other items may affect your tax liability and bottom line.
It’s important to consider your business’ unique situation when applying tax reform changes to this year’s tax return. If you want hands-on guidance on how tax reform will impact you, get matched with a tax advisor. Our advisors can help you determine the best tax strategy for your unique situation.