By Shane Fisher, CPA
The IRS recently released clarifications about qualified business income (QBI) deductions, which should be of help for business owners and decision makers. The QBI deduction is limited to the lesser of 20% of QBI plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income or 20% of taxable income less net capital gain for all taxpayers, regardless of income. You do not need to materially participate in a business to qualify for the deduction. The deduction has two components: QBI and REIT/PTP. This would typically impact businesses where the income earned is taxed as a pass through at the individual level.
The IRS defines QBI as the “net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with U.S. trade or business. Capital gains and losses, certain dividends, and interest income are excluded. W-2 income, amounts received as reasonable compensation from an S corporation, amounts received as guaranteed payments from a partnership, and payments received by a partner for services under Section 707 (a) are also not QBI.”*
The REIT/PTP component consists of qualified REIT dividends through a regulated investment company and PTP income. PTP income may be limited if the PTP operates as a specified service trade or business (SSTB).
The IRS defines an SSTB as “a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets, or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. The principal asset of a trade or business is the reputation or skill of its employees or owners if the trade or business consists of the receipt of income from endorsing products or services, the use of an individual’s image, likeness, voice, or other symbols associated with the individual’s identity, or appearances at events or on radio, television, or other media formats.”*
If you have multiple businesses or pass-through entities, their net QBI (including losses) must be netted in aggregate. Losses carried forward will be treated as lowering your QBI component in the following taxable year. The QBI deduction begins to phase out at $315,000 for married filing jointly and $157,500 for all other filers. The QBI deduction is fully phased out at $415,000 for married filing jointly and $207,500 for all other filers.
The IRS has two forms to assist with the calculation of the QBI deduction. The first is located in the instructions to Form 1040, which is specifically geared to anyone who qualifies for the deduction. The second is located in Publication 535, Business Expenses. This should be used by taxpayers who exceed the threshold amount.
In addition to the above noted items, the IRS provided clarification on self-employment tax, the self-employed health insurance deduction, and the self-employed retirement deduction with regard to QBI: “The above-the-line adjustments for self-employment tax, self-employed health insurance deduction, and the self-employed retirement deduction are examples of deductions attributable to a trade or business for purposes of Section 199A.”* These items must be deducted to calculate QBI.
The IRS’s recent updates have brought some clarification to the QBI deduction. They provide definitions for what exactly constitutes the QBI component, REIT/PTP component, limitations, SSTBs, aggregating income, and carrying forward losses.
* “Tax Cuts and Jobs Act Provision 11011 Section 199A – Qualified Business Income Deductions FAQs,” Internal Revenue Service, July 16, 2019
Shane Fisher, CPA, is vice president of finance at Tri Corner Homes in Harrisburg, Pa., and is a member of the Pennsylvania Institute of CPAs’ CPA Image Enhancement Committee.
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