Your Ultimate Guide to Qualified Business Income
If you’re a small business owner, saving money is your primary goal. There are two main reasons business owners like to save money: To put money in their own pockets or reinvest and grow.
But an often-overlooked strategy for saving money is the Qualified Business Income (QBI) tax deduction. It helps save money and helps you grow your business.
Not everyone is eligible to receive the QBI deduction. But if you are, you can save a significant amount on your next tax return. Read on to find out who the QBI is for, how you file, and how much you can save.
What is QBI?
Let’s start with the basics. At its simplest, the Qualified Business Income deduction helps reduce how much you’ll owe in taxes. Sounds great, right?
The QBI deduction allows self-employed and small businesses to deduct up to 20% of their income from their taxes. This is calculated by taking 20% of:
- Your taxable income for the year (before considering the QBI deduction), minus
- Net capital gains, including qualified dividend income taxed at capital gains rates
Yes, you heard that right: You could deduct up to 20% of your income from this year’s taxes.
Who is Eligible for QBI?
Now that you know what it is, you’re probably wondering if you’re eligible for QBI. If you have a firm grasp of your business, this should be a simple question to answer.
However, there are some new restrictions and limits for total taxable income to bear in mind:
- Single filers must make under $170,050
- Joint filers must make under $340,100
While businesses that generate more than these totals aren’t eliminated, it complicates your filing. If you are above the income limits stated above, or are considered a “specified service trade or business” per IRS regulations, additional forms, calculations and limitations come into play. If you’ve generated over this dollar amount during the fiscal year, it can be challenging to properly calculate and report your QBI deduction.
Not impossible, but it can be a serious headache for your DIY tax prep.
The tax law allows a 20% deduction of qualified business income (QBI) for pass-through entities, which is defined as “a business entity whose income is taxed as the owner’s personal income at the individual rate rather than as business income for federal income taxes.” Here are the types of businesses which can apply:
- Sole proprietorships
- S Corps
Since the QBI covers all of the four main small business types, it’s available to you even if you have another job or source of income. So, if you’re operating an LLC or a sole proprietorship as a side-hustle, you should consider taking advantage of the QBI deduction. This tax break can help you put money back in your pocket to invest in your business.
If you are wondering if you still qualify, it’s always best to contact a professional. A financial advisor can walk you through the intricacies of tax law and ensure you are eligible.
What Profit Qualifies as QBI?
The next step in unfolding the intricacies of QBI is understanding what income qualifies.
QBI refers to your business’s net amount of income, gains, deductions, and losses. In other words, QBI is your business’s net income.
There are a significant set of restrictions in terms of what qualifies for QBI. The IRS explicitly excludes many familiar sources of revenue from your eligible funds:
- Capital gains and losses
- Income from Interest that is not properly allocable to a trade or business
- Foreign currency gains or losses
- Qualified REIT (real estate investment trust) dividends
- Publicly traded partnership (PTP) income
Further, there are some wages and guaranteed payments to partners and shareholders which are ineligible. While there are many resources online that explain the nuance of the law, consulting an expert can help protect you from misfiling.
Also, foreign-based businesses and income generated outside the U.S. are ineligible, as are some wages and payments made to partners and shareholders. When in doubt, it is always best to consult a tax professional or CPA.
How to Report and File Your QBI Deduction
Once you’ve established your business’s eligibility and calculated your qualified income, it’s time to file. And just like any other interaction with the IRS, it’s time to find the correct form!
Don’t worry, this is the easy part. (Well, sort of.)
The primary forms for QBI deductions are forms 8995 or 8995-A. (Yes, there are only two options!) The tricky part comes in having the correct financial information on hand from your business, doing the actual calculation to determine your QBI Deduction and then figuring out the proper form to report this on with your individual tax return. But if you’ve established your total taxable income, and know where you stand regarding the threshold, the choice is then relatively straightforward.
Your choice of form comes down to the income thresholds we mentioned earlier. If your total taxable income is below $170,050 (for single filers) or $340,100 (for joint filers), you will use form 8995.
If your total taxable income exceeds the conventional limits, then (that’s right!) you will use form 8995-A.
Don’t Leave QBI to Chance
When you’re not versed on the ins and outs of tax law, the QBI deduction can be a nightmare to navigate.
Unfortunately, a simple misunderstanding or misinterpretation of the rules can lead to severe issues in the future. Do yourself a favor and bring in a professional to protect yourself against legal and financial trouble.
Let’s be honest, you didn’t start a business so that you could become an expert in tax law. You also probably didn’t plan to spend so much time deciphering IRS rules and verbiage. By partnering with an expert, you can free yourself up to work on your business rather than conducting a self-guided crash course in tax law.
If you feel like you’re in over your head, don’t wait. The financial services team at Semaphore has a wide variety of business solutions to fit your small business needs. From bookkeeping and payroll, taxes and insurance, we have your business covered.
For more information on how we can help you navigate QBI and other tax topics, fill out the contact form at the bottom of this page or call us at 866-736-2444, and we’ll find an immediate solution for your business needs.