The Qualified Business Income (QBI) deduction, also known as the pass-through deduction or section 199A deduction, was established by the 2017 Tax Cuts and Jobs Act (TCJA) and applies to tax years 2018 through 2025.
Most self-employed individuals and small business owners can deduct up to 20% of their qualified business income from their federal income tax with the QBI deduction, regardless of whether they itemize deductions or not.
The amount of the deduction is contingent on the taxpayer's total taxable income, which encompasses wages, interest, capital gains, and business-generated income. The type of business impacts the deduction once taxable income surpasses $182,100, or $364,200 for joint filers.
For incomes below this threshold, the deduction equals 20% of the lesser of taxable income (excluding capital gains and dividends) or the QBI.
>> Go to Section 199A dividends
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This deduction is available for Schedule C filers, including sole proprietorships and other self-employed entities, as well as LLCs, partnerships, S corporations, estates, and trusts. Some rental businesses may also be eligible. However, corporations do not qualify as they have distinct tax benefits under the TCJA.
Nevertheless, not all businesses that are eligible will qualify for the deduction. Specifically, certain service businesses, known as SSTBs, become ineligible when the taxable income reported exceeds $232,100, or $464,200 for joint filers.
If your total taxable income — not just from your business but also other sources — is at or below $182,100 for single filers or $364,200 for joint filers in 2023, you may be eligible for a 20% deduction on your taxable business income. For 2024, the thresholds increase to $191,950 for single filers and $383,900 for joint filers.
However, if your income exceeds these limits, the situation becomes more complex.
This is because, beyond these income thresholds, your eligibility for the pass-through deduction is contingent on the specific nature of your business. Moreover, even if your business is eligible, you may not receive the full 20% deduction, as the qualified business income deduction phases out for certain businesses.
There are several key points to remember regarding the pass-through deduction:
1. There are two distinct 20% figures to consider. The qualified business income deduction can amount to as much as 20% of your taxable business income. Additionally, the pass-through deduction you claim cannot exceed 20% of your overall taxable income.
Here's the process: You calculate your business income and expenses using Schedule C, as you typically would. Then, you determine your adjusted gross income on Form 1040, as you normally do. It is only after these steps that you begin to compute the pass-through deduction.
2. The qualified business income deduction is claimable even without itemizing deductions. In other words, if you opt for the standard deduction, you can still avail of this deduction.
Section 199A dividends derive their name from Section 199A of the tax code, established by the 2017 Tax Cuts and Jobs Act to offer a deduction for pass-through business income. A key feature of Section 199A is the provision of a 20% deduction on dividends distributed from the earnings of domestic REITs.
When Section 199A dividends are distributed, they are documented on Form 1099-DIV in Box 5. These dividends represent a portion of the total ordinary dividends listed in Box 1a. It is not necessary to itemize deductions to be eligible for the 199A deduction, and this deduction does not affect your adjusted gross income.
The Section 199A dividend tax deduction typically allows for a 20% deduction of the amount listed in Box 5 of the 1099-DIV form. Unlike some other types of qualified business income (QBI), such as self-employment profits, this deduction does not reduce at higher income levels. Taxpayers of all income brackets are eligible for the full 20% deduction on their Section 199A dividends.
To claim the Section 199A dividend deduction, taxpayers should use Form 8995 or Form 8995-A, which will then be reported on Line 13 of Form 1040. It's important to note that this deduction does not affect your marginal tax bracket or phaseouts for income-based deductions, such as those for Roth IRA contributions. However, it does reduce your overall taxable income.
At H&CO, we have a team of qualified tax professionals (CPAs) who have a deep understanding of the complexities involved in income tax preparation. Our experts are committed to guiding you throughout the entire process with the utmost care and attention. We provide exceptional service and a personalized approach to help you navigate US and international income tax laws while keeping you up to date with the latest changes.
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