Under prior law, net taxable income from pass-through business entities — including sole proprietorships, S corporations, partnerships and limited liability companies (LLCs) that are treated as sole proprietorships or as partnerships for tax purposes — was simply passed through to owners and taxed at the owners’ rates.
For tax years beginning after December 31, 2017, the new tax law establishes a new deduction based on a noncorporate owner’s share of a pass-through entity’s qualified business income (QBI). This break is available to eligible individuals, estates and trusts. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.
The QBI deduction isn’t allowed in calculating the noncorporate owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.
Limitation on W-2 Wages
For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the noncorporate 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” means depreciable tangible property (including real estate) owned by a qualified business as of the tax year end and used by the business at any point during the tax year for the production of QBI.
Under an exception, the W-2 wage limitation doesn’t apply until an individual owner’s taxable income exceeds $157,500 or $315,000 for a married individual who files jointly. Above those income levels, the W-2 wage limitation is phased in over a $50,000 range or over a $100,000 range for married individuals who file jointly.
Limitation on Service Business Income
The QBI deduction generally isn’t available for income from specified service businesses, such as most professional practices. Under an exception, however, the service business limitation does apply until an individual owner’s taxable income exceeds $157,500 or $315,000 for a married individual who files jointly. Above those income levels, the service business limitation is phased in over a $50,000 range or over a $100,000 range for married joint-filers.
Important note: The W-2 wage limitation and the service business limitation don’t apply as long as taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.
The TCJA is almost 500 pages long and covers a wide range of topics. We’ve summarized only the highlights here. For more detailed information, contact us for insight into how the changes will impact your specific business.
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