By Sheryl Rowling
SAN DIEGO — Did you know that the Tax Cuts and Jobs Act (TCJA) has created a tax savings opportunity for businesses? If your business is not a C corporation, you might qualify for a 20 percent income reduction by means of the Qualified Business Income (QBI) deduction.
Although the rules are complex, it’s worth it to figure out – you could get a big tax savings!
The Basics
To qualify, your business can be any structure other than a C corporation, such as:
- A sole proprietorship
- A partnership
- An S corporation
- A single member LLC
- A multi-member LLCs
As long as your taxable income is less than $315,000 for married couples or $157,500 for singles, you can claim a deduction for 20 percent of your net business income – up to a maximum of 20 percent of your taxable income less capital gains.
Example
George and Gracie have a flower shop that netted $150,000 in 2018. Their total taxable income is $200,000 (not counting capital gains). George and Gracie can deduct $30,000 from their taxable income (20% x $150,000).
Complications
If your taxable income is greater than these amounts, your deductions are limited depending on whether your business is a “service business” or not.
Service Business
If your business is a service business and you make more money than the above amounts, your deduction is limited:
- Full deduction if taxable income is less than $315,000 for married couples or $157,500 for singles.
- Phased out deduction for taxable income between $315,000 and $415,000 for married couples or between $157,500 and $207,500 for singles.
- No deduction for taxable income above $415,000 for married couples or $207,500 for singles.
In other words, service businesses only get a benefit for the QBI deduction if total income is below $415,000 for married couples or $207,500 for singles.
A service business is defined as a business in the areas of:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Brokerage services
- Investing and investment management
- Trading or dealing in securities, partnership interests or commodities
The TCJA exempts engineering and architectural businesses.
Non-Service Business
If your business is not a service business and you make more money than the above amounts, your deduction is limited to 20 percent of taxable income minus capital gains and cannot exceed:
- 20 percent of QBI
- Greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the cost of business assets acquired after 2008.
In other words, if you have high income, to claim the QBI deduction for a non-service business, you must pay wages and/or have substantial business assets.
Example
Ben owns an ice cream distribution business. Net income from the business is $250,000 and his total taxable income is $800,000. The business pays wages of $200,000 and has equipment (acquired after 2008) with an original cost of $500,000. Ben’s QBI deduction is limited to:
- The lesser of 20% of business income or 20% of taxable income: $50,000
- The $50,000 cannot exceed the greater of:
- 50% of wages: $100,000, or
- 25% of wages + 2.5% of business assets: $62,500
Ben’s deduction is $50,000. If Ben’s business income was $600,000, Ben’s QBI deduction would be:
- The lesser of 20% of business income or 20% of taxable income: $120,000
- The $50,000 cannot exceed the greater of:
- 50% of wages: $100,000, or
- 25% of wages + 2.5% of business assets: $62,500
In this case, Ben’s deduction is $100,000.
Conclusion
This article is a brief summary of the new QBI deduction rules. It should not be relied on to prepare your tax return; it should serve only as a guide to alert you of a possible tax benefit. If you believe the QBI deduction applies to you, be sure to consult with a knowledgeable CPA! This is an area of the tax law where a professional is absolutely needed.
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Rowling is a certified public accountant, personal finance specialist, and principal of Rowling & Associates. She may be contacted via sheryl.rowling@sdjewishworld.com