How Exactly Do You Calculate Your QBI Deduction?

The QBI deduction was one of the hottest topics in tax last year, but not even the most experienced tax advisers could tell you how it worked. That’s because the Treasury Department and IRS didn’t issue the final regulations required to interpret the new tax law until the start of the tax filing season. Now that the regulations are out, here’s how to figure out your deduction.

Figure Your Qualified Business Income

Your qualified business income starts as your share of the profits from a sole proprietorship, partnership, S-corporation or other pass-through entity. It does not include any income you took as W-2 wages from that entity.

The surprise announced in the regulations was that you need to deduct certain items from your qualified business income for the purpose of the QBI deduction. These include:

  • The employer’s share of self-employment taxes that you deduct from your adjusted gross income.
  • Health insurance plans that you pay as an employer and deduct from your AGI.
  • The employer’s portion of your tax-deferred (not Roth) retirement account contributions. Note that you do not deduct contributions designated as employee contributions from your QBI.
Once you’ve made those deductions and know your final qualified business income, there are a few other things you need to check.

Are You a Specified Service Business?

The original law contains vague language including “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.” IRS Regulation 1.199A-5(b) removed all doubt by providing a specific list of specified service businesses. They include the following.

  • Doctors
  • Attorneys
  • Accountants
  • Actuaries
  • Performers
  • Consultants
  • Athletes
  • Various financial industry professionals
These categories are specifically defined in the regulations and aren’t open to interpretation as some accountants originally feared. If you’re not on the list in the regulations, you’re not a specified service business.

What’s the Deduction Limit for Your Total Income?

If your total taxable income (including non-business sources) for 2018 was up to $157,500 for a single filer or $315,000 for a joint filer, you got the full 20% no matter your industry.

If your income was above those levels and you’re on the specified service business list, you get a proportionally reduced deduction for income up to $207,500 (single) or $415,000 (joint). For higher incomes, you lose the ability to claim the deduction at all (even on your income up to the cutoff).

If your income was above those levels and you’re not a specified service business, you make two calculations and take the higher amount. These are called the wage and capital limitations.

  • 50% of the W-2 wages your business paid.
  • 25% of the W-2 wages your business paid plus 2.5% of the unadjusted basis in your business’s tangible, depreciable property. That includes things like a building, vehicle, or equipment.

Your Final Answer

Once you make the income limitation calculations, you deduct the lower of these three numbers:
  • Your reduced deduction based on your income and business type (see above).
  • 20% of your original qualified business income.
  • 20% of your total taxable income.

What’s Changing for 2020 and Beyond

There are two upcoming changes confirmed for the 2019 tax year returns filed in April of 2020. The first is that the income thresholds for specified service businesses and the wage and capital limitations will increase slightly. They are indexed to inflation and will adjust every year.

The second is that the IRS will create a new Form 8995 to calculate the QBI deduction. You will include this form in your tax return. Currently, you do not file a form or schedule showing your calculations — you only include the final deduction amount on your Form 1040.

Conclusion

The QBI deduction is relatively straightforward now that the IRS has issued a full set of regulations. However, you may need to plan ahead to maximize your deduction. Talk to a qualified tax professional to see if there are ways to structure your income or expenses to increase your deduction.

Print Friendly, PDF & Email