With The Tax Cuts and Jobs Act of 2017, a new deduction for specific business owners was added called QBI – Qualified Business Income Deduction.
But what is it, and how can it reduce your tax liabilities as a small business owner?
Well, in this episode, I am going to break it down.
Today we will discuss the Qualified Business Income Tax Deduction. The QBI tax deduction is where certain businesses are allowed to deduct 20% of their qualified income.
Businesses operating as sole proprietorships, LLC, partnership, and S corporation are eligible for the qualified business income deduction.
Businesses operating as C Corporation are not eligible. Also, there are other entities such as trust that are eligible for QBI tax deductions. Still, I am only referring to the qualified businesses I just mentioned for this video and article.
The Qualified Income is the net amount of qualified income, gain, deduction, and loss from the qualified businesses I mentioned previously.
For the QBI deduction to work for your business, you can only include taxable income.
Income that doesn't qualify:
- Income such as interest, other passive income, dividends,
- Capital gains or losses,
- Wages income and annuities,
- Amounts received as reasonable compensation from an S corporation,
- Amounts received as guaranteed payments from a partnership
- Payments received by a partner for services other than in a capacity as a partner are not included.
To determine your business's Net Income amount, you will take your
Revenue – Expenses = Net Income or Net Loss
In determining the expenses used to calculate your Qualified Net Income, expenses should be connected effectively with conducting business in the U.S. Also, the expenses must be ordinary and necessary to operate your business.
Determining The Qualified Net Income
For example, let's say your Gross Income is $300,000 and your Total Annual Expenses equals 175,000. That means your Net Income is 125,000. Your QBI tax deduction is 20% of that, which equals $25,000.
Appropriate Business Tax Forms
Now, of course, with this tax deduction, there are caveats and limitations. First, you must include your total taxable income, not just for the qualified business net income. So, let me break this down.
- If you are a Sole Proprietorship or LLC, your business's Profit & Loss will be on a Schedule C.
- If you are an S Corporation, your business's revenue and expense will be on the 1120 S. Then you as the owner will receive a K-1, and the amount on the K-1 will be based on your ownership percentage.
- If you are a partnership, the business's total income and expenses will be on the 1065 form. You will also receive a K-1 based on your ownership percentage.
The information from these forms will carry over or appear on the 1040 form. For 2020, you can find the total taxable income for you as a taxpayer on line 15.
Limitations and Rules
Once you have this number, you have to determine eligibility based on the IRS thresholds and limitations.
- Your total taxable income needs to equal to or be more significant than your net income
- Your total taxable income can not be higher than the IRS threshold amount determine each year. For 2020, the threshold amounts are:
- For married, it's $326,600
- For single, it's $163,300
This deduction can start to phase out if you exceed these thresholds amount, and this deduction can get a little more complicated.
Business Net Loss
If your Net Income resulted in a loss, you would not be eligible to use the QBI deduction, but you can carry over the loss to next year's taxes and use it to benefit your business.
CEO Next Best Steps
As the CEO, the QBI tax deduction will enable you to KEEP more money in your business. But this deduction can be extremely complicated. Therefore, I recommend you seek the help of an experienced accountant or virtual CFO such as Say Yes To Profits to help you file your taxes and determine if you qualify for this deduction.
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