For tax years starting in 2018–2025, the TCJA creates a new deduction for owners of pass-through business entities, such as sole proprietorships, partnerships, S corporations and limited liability companies (LLCs) that are treated as sole proprietorships or as partnerships for tax purposes. The deduction generally equals 20% of qualified business income (QBI), subject to limitations that can begin to apply if taxable income exceeds the applicable threshold — $157,500 or, if married filing jointly, $315,000. The limits fully apply when taxable income exceeds $207,500 and $415,000, respectively.

12/5/18 – If you’re the owner of a sole proprietorship, listen up! Newly released instructions for Schedule C, Form 1040, reflect many of the key tax changes that apply to sole proprietors for tax year 2018. These changes, enacted by the Tax Cuts and Jobs Act, include accounting method liberalizations, limitations on deductions for business interest and business losses, a new deduction for qualified business income, and restrictions on deductions for business meals and entertainment expenses. Read the complete IRS-issued instructions here: https://www.irs.gov/pub/irs-pdf/i1040sc.pdf

QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.

The QBI deduction isn’t allowed in calculating the owner’s adjusted gross income, but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.

When the income-based limit applies to owners of pass-through entities, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.

Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year-end and used by the business at any point during the tax year to produce qualified business income.

Another limitation for taxpayers subject to the income-based limit is that the QBI deduction generally isn’t available for income from specified service businesses. Examples include businesses that involve investment-type services and most professional practices (other than engineering and architecture).

The W-2 wage limitation and the service business limitation don’t apply if your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.

The tax professionals at LBMC can help minimize the tax burden and provide crucial information on an ongoing basis to assist in day-to-day operations. Keep up-to-date on the current happenings on our Federal Tax Reform Resource Center.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.