IRS Clarifies the New 20% Small Business Income Deduction
IRS Clarifies the New 20%
Small Business Income Deduction
It’s not uncommon for tax changes to create questions, especially ones that introduce brand new tax breaks. The small business tax deduction has definitely created many questions which is why the IRS recently issued clarification that will be helpful in understanding and applying the small business tax deduction.
Who Gets The Tax Break?
Most small business owners who operate domestic flow-through entities such as S-corps, partnerships, LLCs, sole-proprietors, trusts and estates where the income is reported to you on Form K-1. Sole proprietors use Schedule C.
General Overview Of The Deduction.
The new write-off was created as part of last year’s Tax Cuts and Jobs Act and can be claimed for the first time in 2018. The full 20% small business deduction is generally available to eligible business owners whose 2018 personal taxable incomes fall below $315,000 (joint) and $157,500 (all others), but it can’t be more than 20% of taxable income minus net capital gains. Stated differently, the tax break is the lesser of those two amounts. See the example below.
Where Is The Deduction Taken?
Even though the deduction is based on the qualified net business income (QBI) of your flow-through business, the actual write-off is taken on your personal income tax return.
How Is The Business Income Deduction Determined?
Nothing is ever easy in the tax world. The deduction consists of a two-part process. Compute the 20% net business income (QBI) amount, then look to your personal taxable income to determine how much of the 20% can be deducted.
EXAMPLE: ABC, a married taxpayer has net QBI of $200,000 from his construction LLC and individual taxable income of $300,000. The maximum 20% QBI is $40,000, with an overall 20% taxable income limit of $60,000. Taxpayer gets the entire $40,000 QBI deduction.
What Is “Qualified” Business Income (QBI)?
The 20% small business deduction calculation is based on the net profits of your flow-through businesses, but excludes capital gains and losses, dividends, and interest income, which is where the “qualified” comes into play. When more than one business partner is involved, the QBI is allocated proportionally.
What If I Exceed The Income Limits?
As stated earlier, the full 20% deduction is available when personal taxable income is less than $315,000 (joint), $157,500 (all other). Those with personal taxable income exceeding these amounts may be subject to limitations or exceptions on how much of the 20% deduction can be used. It is dependent on a detailed formula based on industry type, W-2 wages, and equipment values. For more info on these potential limits Click Here.
Special Rules For Personal Service Companies
Persons in personal service businesses are subject to the same rules, except they lose the entire deduction when taxable income exceeds $415,000 (joint) and $207,500 (all other). Personal service businesses are those in health, law, accounting, actuarial science, consulting, financial services, investing, investment management, and trading where the principal asset is the reputation or skill of one or more of its employees.
What If I Have More Than One “Flow-Through” Business?
You calculate the 20% on each entity separately and then combine them into one amount.
What If I Have A Net Loss?
Losses carry over the following year and are netted against flow-through net income.
Do I Have To Itemize To Take The Deduction?
No, the tax break is available regardless of whether you itemize or use the expanded 2018 standard deduction.
