As the rain slows down, it's time to start cleaning up. If your business was affected by the recent rains, that cleanup will take on a different meaning. It’s easy to determine what kind of cleanup effort has to take place if you’re standing in several inches or feet of water. But if you’re a business owner and you’re trying to determine how to clean up with the new 20% deduction for qualified business income (QBI), you may need to look a little harder.
The Tax Cut and Jobs Act (TCJA) passed in 2017 allowed owners of pass-through businesses (Schedule C, 1065, 1120S) to deduct 20% of their QBI from their form 1040 individual income tax returns. Everyone who owns a pass-through business is eligible, but some businesses have different limits than others. Read below to determine which category you are in.
What is QBI?
QBI is income earned from a sole proprietorship, S Corporation, or partnership. It does not include wages earned as an employee. Basically, it is the net income earned from a business. If you’re looking at your 2018 form 1040, that amount would show up on lines 12 or 17 of Schedule 1. The amount to put on those lines comes from your Income Statement (aka Profit and Loss Statement). It would be the last line on that statement next to the words “Net Income.” Take a moment to look at your Income Statement, multiply your Net Income by 20%, and see how much you could clean up with using the new deduction.
What if my QBI is a QBL?
If your Qualified Business Income is a Qualified Business Loss (QBL), then there is no 20% deduction for the current year. The current year QBL will carry forward and be used to offset QBI in the following year.
Where does this new deduction show up on my Form 1040?
The deduction for the new 20% deduction for QBI is reported on page 2 line 9 of the 2018 Form 1040. The good news is that you do not need to itemize to take this deduction.
The deduction for everyone
No matter your business, if your taxable income is under $157,000 if you file single, $207,000 if you file as Head of Household, or $315,000 if you file married filing jointly, you will receive the full 20% deduction.
What is taxable income?
Taxable income is the aggregate of all your personal income for you (and your spouse if married). Your taxable income is reported on page 2 line 10 of the 2018 Form 1040.
For this hypothetical, let's assume a taxpayer makes $200,000 in profit from his water cleanup business, he files jointly, and there is no other income. He’s able to deduct 20% of his profit, in this case $40,000, from his tax return. So even before any other deductions or the standard deduction, he’s taxed on not $200,000, but $200,000 less 40,000, for a taxable income of $160,000.
Based on the revised tax brackets, the marginal tax rate at play in this example is 22%, meaning the QBI deduction is worth $40,000 x .22 = $8,800. QBI has saved this taxpayer $8,800 in taxes.
The deduction for some
Not every business qualifies for the deduction. Qualified trades or businesses include all trades or businesses, except those classified as a “specified service trade or business” (SSTB). An SSTB is a business that provides services in any one of the following business types: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset is the reputation or skill of one or more employees or owners.
Engineering and architecture services are specifically excluded from the definition of an SSTB and are considered qualified businesses.
I am not an SSTB and my taxable income is above the threshold.
For taxpayers who earn income above the thresholds and are not an SSTB, the deduction is limited to either 50% of the W-2 wages paid by the business or 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of all qualified property, whichever is greater.
A common phrase that is uttered when faced with a cleanup: what now? Begin at the beginning. Assess your situation, gather your resources, consult with your trusted advisors, make a plan, and move forward. Many taxpayers will clean up with this deduction, and you’ll want to be one of them.