What Exactly is the QBI Deduction?

The QBI deduction is part of the Tax Cuts and Jobs Act of 2017 and is designed to help small business owners keep more of their earnings. It applies to income from businesses such as sole proprietorships, partnerships, S corporations, and certain trusts. The idea behind it is to give small businesses a tax break similar to what large corporations receive. The deduction is calculated as 20% of your “qualified business income,” which is essentially your business’s net income after expenses.

Who Qualifies for the QBI Deduction?

Not everyone qualifies for the QBI deduction, but many small business owners do. You might qualify if you’re a:

Sole proprietor: If you operate your business as a sole proprietor, you’re likely eligible for the QBI deduction.

Partner: Partners in a partnership can take the deduction based on their share of the partnership’s qualified business income.

S corporation shareholder: Shareholders of S corporations can also take the deduction based on their share of the company’s qualified business income.

However, not all businesses qualify for this deduction. If your business provides services in areas like health, law, consulting, athletics, or financial services, your eligibility may be limited, especially if your taxable income is over a certain threshold.

Income Limits and the QBI Deduction

The QBI deduction is subject to income limits. For 2023, if your taxable income is below $182,100 for single filers or $364,200 for married couples filing jointly, you’ll likely qualify for the full deduction. If your income exceeds these amounts, your ability to claim the QBI deduction may be reduced or eliminated, depending on the type of business you run.

For service-based businesses, like consultants or lawyers, these limits are especially important. If your income is above the threshold, the deduction begins to phase out, and you may not be able to claim it at all.

How to Calculate the QBI Deduction

Calculating the QBI deduction can be a bit tricky, but here’s a basic overview of how it works:

Start with your Qualified Business Income: This is essentially your net income after all expenses, not including wages you pay yourself as an owner or any investment income.

Apply the 20% deduction: Multiply your QBI by 20%. This is your potential deduction.

Check for limits: If your taxable income exceeds the thresholds mentioned earlier, your deduction might be reduced or limited.

For example, if your business’s net income is $100,000 and you qualify for the full deduction, you could potentially deduct $20,000 from your taxable income, significantly lowering your tax bill.

Structuring Your Business to Maximize the QBI Deduction

There are ways to structure your business to take full advantage of the QBI deduction. Here are some tips:

Limit your income: If your income is close to the threshold, you might consider ways to defer income or increase deductions to stay within the qualifying range.

Consider entity structure: If you’re a sole proprietor or a partner, talk to a CPA about whether restructuring your business as an S corporation could provide additional tax benefits while still allowing you to take advantage of the QBI deduction.

Pay yourself wisely: If you operate as an S corporation, the salary you pay yourself can impact your deduction. Make sure you’re paying yourself a reasonable salary to avoid any IRS scrutiny while still benefiting from the deduction.

Tracking and Reporting Qualified Business Income

To fully benefit from the QBI deduction, it’s crucial to keep accurate records of your income and expenses. Make sure you're separating your business income from any investment income or wages you pay yourself, as these don’t count towards QBI.

Many business owners make the mistake of mixing their personal and business finances, which can complicate tax reporting. Using dedicated accounting software or working with a CPA can help you accurately track and report your QBI, ensuring you don’t leave any money on the table.

Final Thoughts

The QBI deduction is a valuable tool for small business owners, but it’s not as straightforward as it seems. Understanding how to calculate it, who qualifies, and how to structure your business to maximize this deduction can result in substantial tax savings. Working with a CPA can help ensure you’re not missing out on these savings, especially if your income or business structure is more complex.

If you’re unsure whether you qualify for the QBI deduction or want to make sure you’re taking full advantage of it, consider consulting with a tax professional. With the right guidance, you can maximize your deductions and keep more of your hard-earned money in your business.