MAXIMIZING YOUR TAX SAVINGS: UNDERSTANDING THE QUALIFIED BUSINESS INCOME DEDUCTION (QBID)

Introduction

For my next article in the small business tax deduction series, we will discuss the Qualified Business Income Deduction (QBID).? In the world of taxation, staying informed about available deductions can make a significant difference in your financial bottom line. The QBID is no exception.

This deduction was first introduced as part of the Tax Cuts and Jobs Act of 2017 and is designed to benefit small business owners and self-employed individuals .? In practice, it is generally referred to as a flow-through business deduction because it is generally available to any taxpayer that is not a corporation.? But before we get too far into it, this article will explore what the QBID is, who can claim it, and how to go about claiming it.

What is the Qualified Business Income Deduction (QBID)?

The QBID is found in Section 199A of the Internal Revenue Code (IRC) and was originally designed to be a tax break for small business owners and self-employed individuals. Whether it actually does this is up for debate but under this provision, qualified taxpayers can deduct a portion of their business income, thereby reducing their taxable income and potentially lowering their overall tax liability.?

Who Can Claim QBID?

To claim the QBID, you must qualify under three categories.? You must have a qualifying business type, your income must be under a certain threshold, and you must participate in qualified business activities.?

Business Type:

As I mentioned before, the QBID primarily benefits pass-through entities.? Passthrough is a tax term we use to describe certain types of business entities. ? Without getting into too much detail, passthrough entities are not taxed for the income they earn because the tax passes through to its owners.? Entities such as sole proprietorships, partnerships, S corporations, and some trusts and estates are considered pass-throughs because the income is taxed with the owners, partners, or shareholders instead of with the business entity.?

The Code doesn’t actually say “passthrough” anywhere to designate a qualifying business but uses about four pages to include everything but C corporations, which are generally the only non-passthrough entity out there. To make it simple, if you don’t have a C corporation, you probably have a qualifying business.? But remember, not just corporations can be taxed as corporations, so you may want to talk to a tax professional to see what kind of business entity you actually have.

Income Thresholds:

To qualify for the QBID, your income also needs to be under a certain threshold. ? Remember, the qualifying business is determined at the entity level, but the income threshold is determined at the owner level.? For example, if you are a partner in a partnership that makes $5M, but your personal income is still under the threshold, you can still claim the QBID because you claim the deduction, not your business.? So, what is the threshold?

The QBID thresholds in 2022 were $164,900 for single filers and $329,800 for married couples filing jointly. However, these numbers are adjusted for inflation every year, so these figures change over time.? Make sure you talk to a tax professional or consult the latest IRS guidelines for the most accurate information.

Something else important to note is that being over the income threshold does not automatically bar you from taking the QBID either.? Once your income is over the threshold, there is a phase-out calculation that reduces your deduction but doesn’t bar it completely.? In other words, you won’t get as much of a deduction, but you can still get part of the QBID if your income is too high.

Qualified Business Activities:

It’s important to note that not all businesses are eligible for the QBID. Specified Service Trades or Businesses are also not eligible for the QBID.? What are Specified Service trades or Businesses? Well, they are:

• Trade of being an employee,
• Health services,
• Legal services,
• Engineering services,
• Architecture services,
• Accounting services,
• Actuarial sciences,
• Performing arts,
• Consulting,
• Athletics,
• Financial services,
• Brokerage services,
• Trade of marketing your reputation or skill,
• Banking,
• Insurance,
• Financing,
• Leasing,
• Investing,
• Farming,
• Hotels/motels, and
• Restaurants

These terms tend to have their own definitions and meanings so if you aren’t quite sure if you fall under any of these trades or businesses, it might be best to talk to a tax professional.

How to Claim QBID

If you are a small business owner and interested in claiming the QBID on your taxes, how would you go about doing that?? An easy answer would be to just call a tax professional and let them do it for you, but if you are dead set on claiming it yourself you need to go through five important steps.

First, you have to determine whether or not you are eligible for the credit.? You would essentially go through the analysis we just did.? First, do you have a flow-through entity? Next, is your income under the threshold? And finally, do you have a specified services trade or business?? Depending on your answers, you may qualify for the QBID.

Second, you need to calculate your deduction.? The QBID allows eligible individuals to deduct up to 20% of their qualified business income (QBI). Calculating QBI can be complex, as it considers various factors, including business income, deductions, and other variables. You may want to consult a tax professional or use some tax software to accurately calculate your deduction. Form 8995 is usually used to calculate the deduction.

Third, you then report your QBID on the appropriate tax return.? Different business entities use different tax return forms.? But for most taxpayers, you will include your QBID on your Form 1040 or 1040-SR.? You will likely need to include a Schedule C or some other form to show your business income, expenses, and deductions as well.

Fourth, always keep detailed and accurate records of your business income, expenses, and deductions. Yes, the United States has a self-reporting tax system, but sometimes the IRS will require you to prove that you did your taxes correctly.? Remember, you can only claim, or defend, what you can prove so make sure you have documentation just in case you get audited by the IRS.

Finally, stay informed and keep up to date with current tax changes. We are living in a time when the tax code has seen some very significant changes.? Every year there is an addition or retraction of the tax code, and it is the taxpayer's responsibility to know what has changed.? If possible, always consult with a tax professional to make sure you are getting the most out of your taxes.?

Conclusion

Grasping the concept of QBID is essential for small business owners and the self-employed to unlock substantial tax savings. The QBID, introduced through the Tax Cuts and Jobs Act of 2017, offers an opportunity to lower taxable income by claiming a portion of your business earnings. To make the most of the QBID, evaluate your eligibility based on your business structure, income level, and business activities. Calculate the deduction accurately, report it correctly on your tax return (e.g., Form 1040 or 1040-SR), maintain meticulous financial records, and stay informed about evolving tax laws. Seeking professional guidance can help you navigate the QBID's intricacies, ensuring you optimize your tax savings while adhering to IRS regulations.