The 20% Qualified Business Income deduction was one of the big hot topics that came out Tax Reform last year. The new law created a deduction for small business owners who operate pass-through entities, including sole proprietors, LLC’s, S-Corps, and partnerships. Income from such entities may allow business owners to deduct 20% of their qualified business income (QBI).

In some situations, it’s pretty straightforward, while other situations are fair more complex. Let’s walk through a few examples.

Example 1

Molly operates her social media management business as a single-member LLC. In 2019, her taxable net income from her business was $50,000. Molly will be able to take a $10,000 deduction on her 2019 tax return ($50,000 x 20%).

Adding Complexity – Income & Other Limits

The QBI deduction may be subject to limitation if the taxpayer’s QBI is from a business that pays W-2 wages to employees. In addition, the deduction may be limited if the business is a certain specified service trade or business, such as services within the fields of accounting, law, health, and consulting.

Both limitations apply only to taxpayers with taxable income over certain thresholds, which are adjusted annually. For 2019, the taxable income thresholds are $321,400 for married couples filing joint returns and $160,700 for single filers.

Taxpayers who have taxable income above those thresholds may find their QBI deduction reduced or eliminated completely. In those situations, it may be beneficial to contribute to a retirement plan to bring your taxable income below the relevant threshold.

Example 2

Diana owns a photography business that operates as an S-Corp and is a single filer. In 2019, Diana expects to earned about $170,000 from her business. If she contributes $10,000 to a pretax retirement plan, that will bring her taxable income below the $160,700 threshold, helping her to get a full QBI deduction.

But Wait, There’s More (Complications)!

Even for business owners under the taxable income thresholds, a 20% QBI deduction is the LESSER of 20% of QBI or 20% of taxable income less net capital gains.

Example 3

Rachel has a website design business where she makes $60,000. She operates as a sole proprietorship. After taking various deductions (the standard deduction, self-employment tax deduction, etc.), her taxable income for the year is $40,000. In this situation, Rachel’s taxable income of $40,000 is less that her QBI of $60,000, so her QBI deduction is only $8,000 ($40,000 x 20%).

In summary, while the QBI deduction can be an amazing benefit to small business owners, it comes with a lot of complexities, so make sure you are talking to your CPA throughout the year to see how to best maximize the deduction!

Candace is the founder of NewWay Accounting and is a CPA who specializes in working with fellow entrepreneurs. She strives to take the fear and anxiety out of taxes and help empower small business owners to feel more confident and in control of their finances. Because even if money isn’t your jam, you deserve to be successful too!