The recently passed Tax Cuts and Jobs Act includes a significant new tax deduction taking effect in 2018. This deduction should provide a substantial tax benefit to individuals with “qualified business income” from a partnership, S corporation, LLC, or sole proprietorship. This type of income is commonly referred to as “pass-through” income.
While there are a number of limitations and parameters, the deduction is 20% of your “qualified business income (QBI)” from a partnership, S corporation, or sole proprietorship. The business must be conducted within the U.S. to qualify, and QBI is defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business. It’s important to note that specified investment-related items are not included (capital gains or losses, dividends, and interest income), unless interest is properly allocable to the business. QBI would not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided.
Qualified Business Income does not include a specified service trade or business. Excluded businesses include services in the fields of health, law, accounting, consulting, financial and brokerage, and any trade or business where the principal asset is the reputation or skill of the employees or owners. Engineering and architecture services are expressly included in the definition of a qualified trade or business. The phase-in for exclusion for specified services begins for taxpayers with taxable income above $157,500 ($315,000 for joint filers).
Additionally, for taxpayers with taxable income more than the above thresholds, a limitation on the amount of the deduction is phased in based either on wages paid or wages paid plus a capital element. The 20% deduction cannot be greater than either 50% of the taxpayer’s allocable share of the W-2 wages paid with respect to the qualified trade or business or the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate).
The deduction is taken “below the line” and therefore reduces your taxable income but not your Adjusted Gross Income. Taxpayers are eligible for the deduction whether they itemize deductions or take the standard deduction amount on their return. In general, the deduction cannot exceed 20% of the excess of your taxable income over net capital gain. This deduction is set to no longer be available after December of 2025.
There are several complexities surrounding this new deduction and a lot of guidance still to come from the IRS. If you have specific questions or would like help working through the mechanics of the deduction please contact a member of the Barnes Dennig tax team here, or call 513-241-8313.