The Qualified Business Income (QBI) deduction can reduce a client’s tax liability, but computing the deduction is complicated. Let’s define the deduction and review a detailed example of the calculation.
When you understand the details of the QBI deduction, you can provide better tax advice to your clients.
The Qualified Business Income deduction allows owners of sole proprietorships, partnerships, S corporations, and some trusts and estates to deduct a portion of their income. Keep in mind that the QBI deduction expires on December 31, 2025, unless Congress votes to continue the deduction.
The deduction for qualified business income has three components:
Eligible taxpayers can file using itemized deductions on Form 1040 Schedule A or the standard deduction.
Qualified business income refers to net income generated by a qualified trade or business. These items are not included as income for QBI:
Expenses are determined by Internal Revenue Code (IRC) Section 162, which allows businesses to deduct ordinary and necessary expenses incurred to operate the entity.
QBI includes the deductible portion of self-employment tax, self-employed health insurance, and deductions for contributions to qualified retirement plans.
Note that several components of the QBI formula have limitations. QBI may be limited based on W-2 wages paid, unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business, and other factors.
Sole proprietors, partnership partners, and S corporation shareholders may qualify for QBI. Trusts and estates with QBI may also be able to take the deduction.
These businesses cannot take the QBI deduction:
The value of an SSTB is the reputation or skill of its employees or owners. SSTBs include health, law, accounting, performing arts, consulting, athletics, financial services, and investment management businesses.
Address each of these topics to determine if you qualify for the QBI deduction:
When you have this information, you’ll understand how the QBI deduction applies to your situation.
The De Minimis and common ownership rules may impact the QBI deduction.
This rule provides an exception to the SSTB exclusion discussed above.
If either of the rules applies, a taxpayer can generate income eligible for the QBI deduction, regardless of taxable income.
Your business may not be an SSTB, but you provide property or services to another SSTB. If two businesses have a common owner, common ownership rules may impact the QBI deduction.
Follow these steps to calculate QBI. This information is based on the 2024 tax year, the most recent year available.
Assume that Julie operates a home-building business as a sole proprietor and files as a single taxpayer. She generated $150,000 in taxable income in 2024, including $5,000 in net capital gains.
Determine if the SSTB limitations apply to your business. Julie’s occupation does not meet the SSTB definition.
Your taxable income may limit the QBI deduction.
If your taxable income (before the QBI deduction) exceeds the threshold ($383,900 if married filing jointly, and $191,950 for all other returns), your QBI for each of your trades or businesses may be partially or fully reduced.
The formula to calculate the reduction is:
The partial or full reduction is determined by your taxable income. If your taxable income (before the QBI deduction) is:
If your taxable income is below the threshold, file for the deduction using Form 8995 (the simplified version). Taxpayers with income at or above the threshold use Form 8995-A and these instructions to determine the deduction.
Julie’s income is below the threshold for a single taxpayer.
The deduction is the lesser of:
Julie’s QBI deduction is ($150,000 in taxable income – $5,000 net capital gains) X 20%, or $29,000.
Calculating QBI requires precision and careful planning. Compute taxable income correctly, and remove items not used to calculate QBI. Be aware of business entities that don’t qualify (C corporations, for example).
Confirm if your business is an SSTB, and pay attention to the income thresholds.
Take action now to help your clients successfully qualify for the QBI deduction. Get a firm handle on projected taxable income and determine if the income will be below the QBI threshold.
Your client’s filing status, type of business, and various types of income each impact the QBI calculation. Create a plan to maximize the client’s chances of meeting the qualifications.
Tax preparers need tax knowledge and effective software tools to calculate the QBI deduction accurately. Sigma Tax Pro provides industry-leading software solutions and tax preparation support at the lowest prices available. Reach out to Sigma Tax Pro today to learn more.
