How the Qualified Business Income Deduction Could Cut Your Tax Bill by 20 Percent
Last Updated: Jan 8, 2020
The qualified business income (QBI) deduction could save you as much as 20% on your taxes if you meet the qualifications. Find out how this new pass-through deduction works here.
One of the newer tax rules that business owners should be aware of is the Qualified Business Income Deduction (QBI). The deduction, also called Section 199A, is a 20 percent deduction available for qualifying pass-through businesses such as sole proprietorships, S-corporations, and partnerships (not corporations). Like many tax rules this deduction is more complex than it sounds at first, so let’s start with the basics and then we’ll delve a little deeper for those of you who want to take a closer look at the potential savings.
Here three facts to know about the new pass-through deduction and what it applies to
Let’s look at each of these rules as it applies to a freelance business:
You should first determine if your business is an SSTB as mentioned above. The first two examples below assume that your business is not an SSTB. In both of these cases, you would calculate the Qualified Business Income (QBI) from your business. This is simply the net income of your business excluding any salary, wages or payments made to you, the owner. If you have a sole proprietorship, this would be your Schedule C income.
You will need to determine the ratio of the income you may have over the threshold limitation of $160,700 for single taxpayers and $321,400 for Married Filing Jointly taxpayers.
Keep in mind also that if your taxable income reaches $210,700 (single filer) or $421,400 (married joint filer), the QBI deduction is limited to 50 percent of your W-2 wages from that business or the sum of 25 percent of W-2 wages from the business, plus 2.5 percent of any qualified property. Then, using the income threshold stated above and the phase-out amount of $210,700/$421,400 to calculate the limitation on a prorated basis.
Here is an example of how to do it assuming:
Given this hypothetical situation, your maximum pass-through deduction is 20 percent of your $300,000 QBI, which equals $60,000. With your taxable income being over $421,400, any pass-through deduction you claim is limited to the greater of (i) 50 percent of the W-2 wages paid to your employees, or (ii) 25 percent of W-2 wages plus 2.5% of your office building’s $250,000 basis. (i) is $100,000 (50% x $100,000) = $50,000; (ii) is (2.5% x $250,000) + (25% x $100,000) = $31,250. Since (i) is greater than (ii) you would have to take the lesser amount of $31,250 as the pass-through deduction.
For our example, assume:
To calculate, multiply your deduction prior to the phase-out—in this case, it is limited to 50 percent of the W-2 wages you paid since there is no qualified property. This is equal to $30,000 (50% x $60,000 W-2 wages = $30,000). With your phase-out percentage being 45 percent you get 55 percent of the full deduction which is equal to 55% x $30,000 = $16,500.
This new pass-through deduction may offer significant tax savings for your business, but it is also somewhat complicated. Could it save you 20 percent? Maybe—it depends on how the specific rules of this deduction apply to your situation. This is where enlisting a tax professional to do some tax planning and calculations may be helpful. Whether you choose to work with a tax pro or to go it alone, it’s worth considering whether this new tax deduction will impact this year’s tax bill.
Jonathan Medows is a New York City-based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. His website, www.cpaforfreelancers.com features a blog, how-to articles, and a comprehensive freelance tax guide.
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