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QBI: Qualified Business Income Deduction Explained and Tax Strategy | 20% Pass Thru Deduction 199A

This limited time 20% deduction is called a qualified business income deduction and it's also called a QBI deduction or a Section 199A deduction. It's only supposed to last to the end of 2025 but Congress might decide to extend it. Although QBI is based on business income, the 20% qualified business income deduction is taken on your personal 1040 federal tax return and it is not a deduction on the business return itself.
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00:00 - Who can take the 20% deduction
00:39 - What is the 20% deduction
02:13 - Deduction limits
03:45 - Rental activities with a net loss
05:03 - Ways to increase W2 wages
06:50 - Tax strategies for personal services business
07:43 - Tax strategy for a partnership
08:39 - Tax strategies to reduce taxable income
10:43 - Conclusion

TRANSCRIPT:
Qualified business income is basically the net income from your business but without investment income and losses, any income from outside the United States, and any income that cannot be allocated to your business.

You can deduct UP TO 20% of your qualified business income, plus 20% of any qualified real estate investment trust dividends and qualified publicly traded partnership income.

Although the deduction is calculated on your business income it will be limited by the taxable income on your personal return. The total taxable income on your 1040 personal tax return from all sources will be counted to determine if you will be able to actually take a QBI deduction on your personal return each year.

This is where the qualified business income deduction limits come into play. Actually, there are three limits that you have to consider.

So, the first QBI limit is an overall limit. The QBI deduction will not be more than 20% of the taxable income on your personal return after you subtract your net capital gains income. This limit takes into account all net income from the flow through businesses that you operate and income such as your W2 wages. So, the lower the taxable income on your personal return, the lower your qualified business income deduction.

The next two limits are based on your actual taxable income amount. For 2023, if your 1040 taxable income is at or below $182,100 for single filers or $364,200 for joint filers, then you will get the full 20% deduction.

The third limit is, if your income for 2023 is over $232,100 for single filers and $464,200 for joint filers, your type of business, the wages that you pay to your employees, and certain business assets that you depreciate, can reduce or eliminate your QBI deduction all together.

If your business offers personal services and your taxable income is over the third limit, then you cannot take a QBI deduction at all. Personal service businesses include professions such as health, law, consulting, athletics, actors, financial or brokerage services, accounting, or other businesses that mainly depend on the reputation of the employee or owner.

If you are NOT a personal service business and your taxable income exceeds the third limit, then your QBI deduction will not exceed the greater of:

a) 50% of your share of the W-2 wages paid to employees, OR

b) 25% of wages, plus 2.5% of the initial cost of your depreciable assets

So here are a few strategies you might be able to use to increase your W2 wages.

If your business is using independent contractors for services, you may want to hire employees to do those services instead.

Another thing that you can do is increase wages or give bonuses to employees at year end.

If you have a business that has both specified service business income and non-specified service income, then you could consider separating the business into TWO separate businesses.

Here is a tax strategy that you can consider if your business is a partnership. If you are in a partnership and you are receiving guaranteed payments, you should stop paying yourself guaranteed payments.

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