QBI Tax Deduction: What It Is And How Does It Work
The Qualified Business Income (QBI) deduction is a type of tax deduction that’s designed for self-employed people and small trade or business owners. Using the QBI deduction, eligible taxpayers can deduct up to 20% of their qualified business income when filing their annual return. In this guide, we’ll go over everything you need to know about the QBI deduction.
- The Qualified Business Income (QBI) deduction allows certain businesses to save money on their tax return.
- Only certain kinds of business entities qualify for the QBI deduction.
- QBI factors in your total taxable income, which cannot exceed certain thresholds if you want to be eligible to claim the deduction.
- Accounting software can make it simpler to calculate and claim your QBI deduction.
Table of Contents
- What Is a Qualified Business Income Deduction?
- Who Qualifies for QBI Deductions?
- Who Is Not Eligible for a QBI Deduction?
- How Does Qualified Deduction Work?
- QBI Deduction Limitation
- Streamline Your Tax Preparation With FreshBooks
- Frequently Asked Questions
What Is a Qualified Business Income Deduction?
A QBI deduction is a tax write-off intended for small trade or business owners and solo entrepreneurs. It allows these smaller companies to pay less for their income tax bill when it comes time to file.
Qualified business income, or QBI, refers to your business’s net profit, with a few exceptions. QBI excludes your capital gains and losses, some dividends, interest income, income earned from outside the US, and guaranteed payments. Aside from that, all of your trade or business income is factored in when calculating your qualified business income for the year.
Who Qualifies for QBI Deductions?
QBI deductions can be a big benefit in reducing your tax bill. Before you bank on this income tax write-off, be sure to double-check that you’re eligible to claim it. The QBI deduction is intended for those entrepreneurs and small businesses with ‘pass-through’ income—in other words, trade or business income that you report on your personal tax return.
Only certain types of business entities can claim QBI deductions. These include:
Beyond these criteria, there are a few other rules to keep in mind. If your total taxable income —including income outside of your trade or business—is above a certain limit (more on this later), your deduction might be less than 20% or you might not qualify at all for QBI. The most important test for eligibility is whether or not your company is a ‘specified service trade or business’, or SSTB for short.
If you’re a financial planner, lawyer, doctor, consultant, or even an actor, your work may be classified as an SSTB. If you’re a high earner in one of these fields, you won’t be able to claim the QBI deduction once you hit a total taxable income of $232,100 for single filers or $464,200 for those married filing jointly. You’ll qualify for a full or at least partial deduction if you earn less than those threshold amounts.
If you own a business that isn’t considered SSTB but is still over the taxpayer’s taxable income limits, there’s a test you can use to see if you qualify for any amount of QBI deduction. This is tied to the amount you pay in W-2 wages, as well as the total value of property owned by the business. Your QBI will be limited to the lesser of these two numbers.
Navigating the IRS’ more complex deductions, such as QBI deductions, doesn’t need to be too complicated. Learn how FreshBooks takes the pain out of tax preparation in the video below.
Who Is Not Eligible for a QBI Deduction?
There are a few cases where you simply won’t be eligible for the QBI deduction on your annual tax return. This includes non-SSTB businesses that earn a total taxpayer’s taxable income of more than $182,100 (for single filers) or $364,200 (for joint filers).
If your business isn’t a pass-through entity, you probably won’t be able to claim a QBI deduction either. Income earned through a C corporation or through providing services as an employee is not eligible for a QBI deduction.
How Does Qualified Deduction Work?
Before you can enjoy the tax benefits of a Qualified Business Income deduction, you’ll need to understand the process of calculating and claiming it for your specific business situation. Provided you aren’t trying to claim the deduction as an SSTB and your total taxable income is under the total taxpayer’s taxable income limit, you would claim whichever of these 2 amounts is lesser:
- 20% of the QBI component of your total taxable income
- 20% of your taxable income after subtracting any net capital gains made that year
In order to compute and claim your QBI deduction, you’ll need 1 of 2 IRS forms: either Form 8995, Qualified Business Income Deduction Simplified, or Form 8995-A, Qualified Business Income Deduction. If you are claiming the deduction for a non-SSTB business and are under the income limits, you can use Form 8995. If you are trying to claim a QBI deduction for a business that has taxable income over the income threshold, you’d then use Form 8995-A.
No matter which of these two forms you use, you’ll need to fill it out and run through the calculations to determine what the amount of your QBI deduction should be. When you’re done, you will attach it to your federal tax return when it comes time to file.
QBI Deduction Limitation
The QBI can spell a significant tax break for the entrepreneurs and small businesses that need it. But it doesn’t come without any limitations. If your business isn’t classified as a ‘specified service trade or business’ (SSTB), and your total taxable income is above $182,100 for single filing or $364,200 for people who are married filing jointly, the deduction may be partially or fully reduced to the greater of 50% of W-2 wages paid by the business or 25% of W-2 wages plus 2.5% of the UBIA of qualified property from the qualified trade or business. If your business is classified as an SSTB, you will not be able to claim the QBI deduction once your taxable income reaches $364,200 for married filing jointly and $182,100 for filing all other returns.
Streamline Your Tax Preparation With Freshbooks
As with so many complexities of tax law, QBI deductions and your eligibility to claim them can sometimes be a bit complicated. Whether it’s determining your total taxable income for the year or working on calculating the deduction you’re eligible to claim, these little details can make a big difference when done right. FreshBooks accounting software can help small businesses and entrepreneurs save more money by streamlining tax prep steps for your QBI deductions. Try FreshBooks free!
FAQs About QBI Tax Deduction
Do you have more questions about the Qualified Business Income Tax Deduction and how to claim it? Here are answers to some of the frequently asked questions on QBI.
What are the phase-out income limits for QBI?
For the tax year 2023, the phase-out income limits are $464,200 for married filing jointly and $232,100 for all other taxpayers.
What qualifies as a specified service business?
Specified service trade or business (SSTBs) refers to any trade or business that provides services in the fields of accounting, law, health, performing arts, consulting, brokerage services, financial services, athletics, or actuarial science. Any other business/trade where the taxpayer receives income for product/service endorsements, use of image or likeness, or media appearances are also considered SSTBs.
Where does QBI go on your tax return?
QBI deductions are filed on either Form 8995, Qualified Business Income Deduction Simplified for non-SSTBs, or Form 8995-A, Qualified Business Income Deduction for SSTB businesses. Once these forms are filled out, you will report the QBI deduction amount on line 13 of form 1040 and attach them to the rest of your individual tax return when it’s time to file.
What is an example of a QBI deduction?
Here is a simple example of QBI deductions: Your total taxable income for the year is $150,000. Of this amount, $60,000 is Qualified Business Income, or QBI. Multiply $60,000 by 20% to arrive at your final QBI deduction amount, which is $12,000.
What is the rule for QBI wages?
For non-SSTB businesses paying W-2 wages with business income above the highest QBI threshold, a good rule to abide by is the 2/7 rule. In order to qualify for the highest possible deduction, the wages paid should equal about 2/7th of your business income.
How do you know if I have a QBI deduction?
You are eligible to claim a QBI deduction if you have ownership interests in a qualified business or trade. Qualified business entities include partnerships, limited liability companies (LLCs), S corporations, and sole proprietorships. These are also known as pass-through entities. If your business entity type qualifies, you’ll need to calculate the QBI deduction considering your total taxable income and the threshold limit amounts set for the tax year.
About the author
Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at http://www.sixfiguresaccounting.com/ .