The information in this article is up to date for tax year 2024 (returns filed in 2025).
Qualified business income (QBI) can lower your taxable income by 20%. This article explains what QBI is, who qualifies, and how to maximize your QBI deduction.
Key Takeaways
- Qualified Business Income (QBI) is key to reducing taxable income for eligible businesses, including sole proprietorships and partnerships.
- Income limits and phase-out thresholds dictate eligibility for the QBI deduction, with adjustments each year.
- Certain income types, such as capital gains and wage income, are excluded from QBI, so understanding what qualifies is essential for accurate tax reporting.
What Is Qualified Business Income?
Qualified Business Income (QBI) is the net amount of income, gains, deductions, and losses from any qualified trade or business. Essentially, it is the net income from eligible business activities. This includes income from businesses operated as sole proprietorships, partnerships, S corporations, and specific trusts. Knowing what constitutes QBI is crucial for maximizing your deduction.
To qualify, the income must be effectively connected to a trade or business conducted within the United States. This means that not all income types are eligible. Concentrating on net income from eligible activities reveals how the QBI deduction can significantly lower your taxable income.
What is the Qualified Business Income Deduction?
The Qualified Business Income (QBI) deduction is a provision under the Tax Cuts and Jobs Act that allows eligible taxpayers to deduct up to 20% of their qualified business income from their taxable income. This deduction is specifically designed for owners of pass-through entities such as sole proprietorships, partnerships, and S corporations. By reducing the taxable income, the QBI deduction helps small business owners and self-employed individuals lower their overall tax liability, providing a significant tax break. However, it is important to note that the QBI deduction does not reduce self-employment tax, and certain income types like capital gains and wage income are excluded from the calculation.
Eligibility Criteria for the QBI Deduction
The QBI deduction is designed to benefit self-employed individuals, gig economy workers, freelancers, and small business owners. If you operate as a sole proprietor, in a partnership, or through an S corporation, trust, or estate, you can claim the QBI deduction.
However, income from C corporations is not eligible, nor is wage income included in the calculation of QBI. Additionally, specified service trades or businesses (SSTBs) face stricter rules, particularly when taxable income surpasses set thresholds.
Understanding these criteria ensures your business can qualify for the maximum deduction.
Sole Proprietorships and Partnerships
Sole proprietorships and partnerships are among the business types whose owners can claim the QBI deduction. These include sole proprietorships, LLCs, partnerships, S corporations, and certain rental enterprises.
The QBI deduction allows these business owners to deduct a percentage of their qualified business income from their taxable income, providing a substantial tax break.
S Corporations and LLCs
S corporations and LLCs also qualify for the QBI deduction, provided they meet specific eligibility criteria. These entities, like sole proprietorships and partnerships, can claim the deduction if they adhere to the set guidelines, making it a valuable benefit for small business owners operating in these structures.
Income Limits and Phase-Out Rules
For tax year 2024, the income threshold for single filers is $191,950, and for married couples filing jointly, it is $383,900. If your income exceeds these limits, the QBI deduction starts to phase out. The phase-out range for single filers is from $191,951 to $241,950, and for joint filers, it is from $383,901 to $483,900. When your income falls within these ranges, the deduction is gradually reduced until it phases out completely.
Looking ahead to tax year 2025, the income thresholds will increase to $197,300 for single filers and $394,600 for joint filers. It’s essential to stay updated on these changes to ensure you accurately calculate your deduction.
If your business is classified as an SSTB, the QBI deduction may be reduced or eliminated based on your income levels. Exceeding the specified phase-out threshold means you become ineligible for the QBI deduction. Understanding these limits and rules can help you plan your finances better and maximize your deductions.
Calculating Your QBI Deduction
The QBI deduction allows for a tax deduction of up to 20% of qualified income derived from eligible business activities. This means qualifying individuals can deduct as much as 20% of their qualified business income from their taxes. Additionally, eligible taxpayers may deduct an extra 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income along with their QBI deduction.
To compute your QBI deduction, use IRS Form 8995. This form ensures compliance with tax regulations for those claiming the deduction. The calculation may require different worksheets based on your taxable income. Comparing your QBI to multiple thresholds and taking the lesser amount helps maximize the deduction. File your taxes with ezTaxReturn and we’ll do the math for you.
Identifying Qualified Business Income
Qualified business income consists of net amounts from various sources. These include income, gain, deduction, and loss derived from any qualified trade or business. To be considered QBI, the income must be effectively connected to a trade or business conducted within the United States. This means that only the net income from eligible business activities qualifies for the qualified business income deduction.
Accurately identifying all components of your business income, including deductions and losses connected to your trade or business, ensures correct QBI calculation and maximizes your deduction.
Applying Income Limits
When calculating your QBI deduction, you need to consider total taxable income, type of business, employee pay, and property value. If your income exceeds the threshold, you must choose between different methods to calculate your QBI deduction. These limits ensure that only those within specified income ranges can benefit fully from the deduction.
Understanding and correctly applying these limits allows for optimization of your QBI deduction through careful planning and accurate reporting of your total taxable income.
Using IRS Forms
To claim the QBI deduction, eligible business owners must use IRS Form 8995. This form needs to be attached to your personal tax return to ensure compliance with tax regulations. Using the correct forms and adhering to IRS guidelines helps avoid common pitfalls and ensures your QBI deduction is maximized. Let ezTaxReturn help you claim your QBI deduction with accurate forms and calculations. Get started today!
What Is Excluded From the QBI Deduction?
Not all types of income qualify for the QBI deduction. The following types of income are excluded from QBI:
- Wage income
- Capital gains or losses
- Items that are not correctly includable in taxable income
- Income that is not effectively connected with the conduct of business within the United States
- Commodities transactions
- Foreign currency gains or losses
- Certain dividends and payments in lieu of dividends
- Income, loss, or deductions from notional principal contracts
- Guaranteed payments from a partnership
- Reasonable compensation from an S corporation
- Annuities that aren’t connected to the trade or business
- Qualified real estate investment trust (REIT) dividends
- Publicly traded partnership (PTP) income
Knowing these exclusions is essential for accurate calculation.
Guaranteed payments received from partnerships are another form of income that is excluded from QBI. Interest income that cannot be allocated to a trade or business does not qualify. Additionally, certain types of rental income, such as those from properties used as residences or triple-net leases, are explicitly excluded from QBI.
Understanding exclusions helps avoid mistakes and accurately determine eligible income for the deduction.
Special Considerations for Specified Service Trades or Businesses
Specified service trades or businesses (SSTBs) are service-based businesses relying on reputation or skill, such as those in health, law, accounting, consulting, athletics, and financial services. For these businesses, the taxable income threshold above which they cannot claim the QBI deduction is $241,950 for individuals and $483,900 for married couples filing jointly. The specified service trade or business is particularly affected by these thresholds.
If your taxable income exceeds $241,950 for individuals, SSTBs are disqualified from claiming the QBI deduction. Total taxable income, which includes wages, spouse’s wages, interest, dividends, capital gains, and rental income, determines whether a taxpayer’s taxable income can qualify for the QBI deduction.
Anti-abuse regulations exist to prevent manipulation of business structures to exploit QBI deductions related to SSTBs. Grasping these considerations is essential for SSTBs to navigate the QBI deduction effectively.
Impact on Self-Employment Tax
While the QBI deduction can significantly reduce your taxable income, it does not reduce income tax or self-employment tax. This distinction is important for self-employed individuals managing their tax responsibilities. The QBI deduction allows eligible taxpayers to deduct a portion of their business income from their taxable income, but it does not lower the amount of self-employment tax owed.
Recognizing the effects of the QBI deduction on your overall tax situation is crucial. While it provides a substantial benefit by reducing taxable income, you must still account for self-employment taxes separately. Proper planning and consultation with a tax professional can help you manage these aspects effectively.
Rental Income and QBI
Rental income can qualify as QBI if the rental activities meet the criteria for being a trade or business under IRC § 162. Rental enterprises must keep separate records of income and expenses for each property to qualify. This meticulous record-keeping ensures that you can justify the inclusion of rental income as QBI.
For rental enterprises existing less than four years, at least 250 hours of rental services must be performed annually to qualify for QBI. Rental properties managed by a real estate professional can also qualify if specific participation criteria are met. Meeting these criteria and maintaining proper documentation is key to including rental income in your QBI deduction.
Additional Deductions and Benefits
The QBI deduction allows taxpayers to deduct up to 20% of their qualified business income, plus 20% of qualified reIT dividends and PTP income. This means you can also benefit from deductions related to a qualified reit dividend and publicly traded partnership income. These additional deductions can enhance your overall tax savings.
Combining the QBI deduction with these additional benefits maximizes your tax deductions. This holistic approach to tax planning ensures that you leverage all available deductions to reduce your taxable income effectively. Knowing these benefits and how to apply them can result in substantial tax savings.
Summary
In summary, the Qualified Business Income (QBI) deduction offers significant tax-saving opportunities for small business owners and self-employed individuals. Understanding the eligibility criteria, income limits, calculation methods, and exclusions is essential to maximize this deduction. By staying informed and utilizing the correct IRS forms, you can ensure compliance and optimize your tax savings.
As you navigate the complexities of tax law, remember that planning and accurate record-keeping are key. Whether you’re a sole proprietor, part of a partnership, or running an S corporation or LLC, the QBI deduction can offer substantial benefits. Take the time to understand these provisions and use ezTaxReturn to make the most of your deductions. Now, you’re equipped to unlock the full potential of your QBI deduction and enhance your financial well-being.
Frequently Asked Questions
Who is eligible for the QBI deduction?
If you’re self-employed, a freelancer, or run a small business as a partnership or S corporation, you’re likely eligible for the QBI deduction. This benefit is designed to help those who earn income through pass-through entities.
What types of income are excluded from QBI?
QBI excludes income like capital gains, wage income, unrelated interest, guaranteed payments from partnerships, and specific rental income. So, if you’re figuring your QBI, make sure to leave these out!
How do income limits affect the QBI deduction?
Income limits play a crucial role in the QBI deduction because if you earn more than $182,100 (single filers) or $364,200 (joint filers) in 2023, your deduction begins to phase out. Essentially, the more you earn beyond those thresholds, the less you can deduct.
Can rental income qualify for the QBI deduction?
Absolutely, rental income can qualify for the QBI deduction if your rental activities are considered a trade or business under the IRS guidelines and you keep good records. Just make sure you’re meeting those criteria!
Does the QBI deduction reduce self-employment tax?
The QBI deduction does not reduce your self-employment tax; it only lowers your taxable income. So, you’ll still be on the hook for the self-employment tax amount.
The articles and content published on this blog are provided for informational purposes only. The information presented is not intended to be, and should not be taken as, legal, financial, or professional advice. Readers are advised to seek appropriate professional guidance and conduct their own due diligence before making any decisions based on the information provided.
