The Tax Cuts and Jobs Act of 2017 resulted in a massive change in the American tax system. The Qualified Company Income Deduction (QBID), often known as Section 199A, is one provision that helps many business owners.
The provision permits particular sole proprietors, S corporation and partnership owners, and partnerships to deduct up to 20% of their qualifying business income (QBI) from their taxable income if a qualified business or trade generates it.
What is a qualified business income deduction?
The qualified business income deduction (QBI) is a tax break that allows self-employed and small-enterprise owners to deduct up to 20% of their eligible business income on their federal income taxes.
To qualify, the total taxable income in 2021 must be less than $164,900 for single taxpayers or $329,800 for joint filers. The restrictions will increase to $170,050 for single taxpayers and $340,100 for joint filers in 2022.
If you exceed that threshold, numerous IRS regulations govern whether your company income is eligible for a full or partial deduction.
Who qualifies for qualified business income deduction?
The qualifying business income deduction is available to persons with “pass-through income,” which is business revenue reported on your personal tax return.
The following entities are eligible for the qualifying business income deduction:
- Sole proprietorships
- S-corporations
- Companies with limited liability (LLCs).
How to qualify for QBI
Suppose your total taxable income — not just business income but also other income — is at or below $164,900 for single filers or $329,800 for joint filers in 2021. In that case, you may be eligible for the 20% deduction on taxable business income. The restrictions will increase to $170,050 for single taxpayers and $340,100 for joint filers in 2022.
However, if your income exceeds these boundaries, it’s time to rethink your options.
Here’s why: If your income exceeds those restrictions, your eligibility to claim the pass-through deduction is dependent on the specific type of your business. Even if your company qualifies, there’s a risk you won’t get the whole 20% tax savings because the qualifying business income deduction is tapered down for some companies.
What effect does taxable income have on the QBID?
If the taxpayer’s primary source of income is their passthrough business, they will most likely be unable to deduct the full 20% of their QBI. This is because the QBID must be the smaller of 20% of the QBI component plus the REIT/PTP component OR 20% of the taxpayer’s taxable income before the QBID, less net capital gains, and qualifying dividends recorded on the return.
Their taxable income will be less than their QBI since standard or itemized deductions and the deductible amount of the self-employment tax lower taxable income. They will most likely be able to deduct only 20% of their taxable income before the QBID.
Where will this deduction appear on my tax return?
The qualifying business deduction is applied to the taxable income of the business. That is, it is determined after subtracting the standard deduction and any itemized deductions from the adjusted gross income (AGI). Because it is based on the business’s taxable income, the qualified business deduction is calculated independently for each firm.
What is the purpose of this tax break?
The qualifying business income deduction attempts to level the playing field between pass-through businesses and C corporations, both of which benefit from lower tax rates.
Conclusion
The recent tax changes show that the government wants to support small businesses and reward entrepreneurs. The qualifying business income deduction is one of the provisions in the Tax Cuts and Jobs Act that supports small businesses and should help many business owners keep more of their profits.
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