The top tax rate for C Corporations has been reduced from 35% to 21%. In order to place individual business owners and passthrough business owners in a similar tax rate situation, the Tax Cuts and Jobs Act 2018 (TCJA) added a 20% qualified business income deduction.
For service businesses, such as consulting, accounting, financial services, health, and law, the deduction is limited for taxable income over $315,000 for joint filers (or $157,500 for single filers and trusts) and completely phased out for taxable income over $415,000 for joint filers (or $207,500 for single filers and trusts). For other trades or businesses, the deduction is limited for taxable income over $315,000 for joint filers (or $157,500 for single filers and trusts).
While the TCJA was meant to simplify the tax code, the QBI deduction is anything but simple. The calculation is complex and involves many moving parts. The deduction is subject to multiple limits based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and/or the unadjusted basis of qualified property held by the trade or business.
One strategy to qualify for the QBI deduction is to try and keep taxable income under the thresholds. This can be accomplished using the traditional methods of loss harvesting, deferring income, and accelerating deductions. There are additional steps which can be taken to lower income, such as setting up a defined benefit plan in the business and/or gifting part of the business to a trust.
