The Basics: Qualified Business Income (QBI) Deduction

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a significant change in the tax landscape for business owners by establishing the Qualified Business Income (QBI) deduction. It’s important to note that this deduction is temporary, set to expire at the end of 2025 unless Congress takes further action.

The Basics of the QBI Deduction

Qualified business income (QBI) is defined as the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business, excluding capital gains or losses, dividends, interest income, or income earned outside the U.S.

The QBI deduction is written off at the owner level. It can be up to 20% of:

• QBI earned from a sole proprietorship or single-member LLC that’s treated as a sole proprietorship for tax purposes, plus
• QBI from a pass-through entity, meaning a partnership LLC that’s treated as a partnership for tax purposes, or S corporation.

QBI can also include up to 20% of eligible income from publicly traded partnerships and up to 20% of eligible dividends from real estate investment trusts.

The QBI deduction was designed to provide relief to small business owners and entrepreneurs, aiming to level the playing field with the corporate tax rate reductions also implemented by the TCJA. By allowing individuals to deduct a portion of their qualified business income, it helps reduce the effective tax rate on business income for eligible taxpayers.

At higher income levels, unfavorable QBI deduction limitations come into play. These income limits are indexed annually for inflation. In general, total taxable income in 2023 must be under $182,100 for single filers or $364,200 for joint filers to qualify. In 2024, the limits rise to $191,950 for single filers and $383,900 for joint filers.

If you’re over that limit, complicated IRS rules determine whether your business income qualifies for a full or partial deduction.

The sunset provision, which is attached to the QBI deduction introduces uncertainty for taxpayers, underscoring the importance of understanding the current tax landscape and planning ahead. Without congressional action, the QBI deduction will cease to exist after 2025, potentially resulting in increased tax liabilities for affected individuals.

Strategies for Qualified Individuals

Given the impending expiration of the QBI deduction, qualified individuals should consider proactive tax planning strategies, unrelated to the QBI deduction, to maximize benefits while they are still available and prepare for potential changes in the future. Here are some key strategies to consider:

• Maximize Deductible Business Expenses: Review and optimize business expenses to reduce taxable income. This may include deferring income, accelerating deductions, and leveraging available credits and deductions. For tax years beginning in 2024, you can potentially claim first-year depreciation Section 179 deductions of up to $1.22 million for eligible asset additions (subject to various limitations). For eligible assets placed in service in 2024, 60% first-year bonus depreciation is available. For 2023, the maximum Sec. 179 deduction was $1.16 million. For 2023, the bonus depreciation percentage was 80%.
• Evaluate Entity Structure: Assess whether the current business entity structure is the most tax-efficient option given individual circumstances and goals. Depending on factors such as income level, industry, and long-term objectives, restructuring the business entity could result in possible tax savings.
• Utilize Retirement Plans Contributions: Explore retirement plan options such as SEP-IRAs, SIMPLE IRAs, or solo 401(k) plans to reduce taxable income and maximize retirement savings. Contributions to these plans are generally deductible, providing an additional avenue for tax planning and wealth accumulation.

Main Street Tax Certainty Act Proposal

Recognizing the significance of the QBI deduction for small businesses and the uncertainty surrounding its future, lawmakers last year proposed the Main Street Tax Certainty Act to extend the deduction beyond its current expiration date. This proposed legislation seeks to provide stability and predictability for small business owners by making the QBI deduction permanent or extending it for a longer period.

Please contact your LMC professional if you have questions on how QBI deduction impacts you.