Many people are aware that the tax rate for C-Corporations lowered to 21% across the board, but what many do not know is that there is a potential 20% deduction on Qualified Business Income (QBI) for owners of pass-through entities, Schedule C businesses and even Schedule E rental properties. This means that 20% of your QBI is tax free each year. Although the rules and limitations for the QBI deduction are quite difficult and complex for taxpayers whose taxable income is higher than $315,000, the rules are quite simple for those who make less than $315,000.
QBI is the business income associated with your business or rental property. Regardless of what you do for a living, if your taxable income is less than $315,000, you can get an automatic 20% deduction of your QBI. No strings or limitations attached. For example, if I run a small construction company that has a profit of $100,000 in 2018 and I have taxable income on my 1040 of $250,000. The $100,000 profit is my QBI. Since my taxable income is less than $315,000, I will get a 20% or $20,000 deduction of my QBI that is tax free. Meaning, I will only pay tax on 80% or $80,000 of my profit.
Now, if your taxable income is over $315,000, you could still be entitled to a deduction. If you meet all the qualifications, you could still be entitled to 20%. However, it is not 20% or nothing. The deduction will just lower depending on certain limitations such as wages paid and the value of unadjusted business property. The purpose of this section of the Tax Cuts and Jobs Act is to benefit the owners of non C-Corporation businesses. This is a way of lowering the effective tax rate for individuals in order to help bridge the gap between them and C-Corporations.
Please contact us if you would like us to perform an analysis and calculate your QBI deduction for you. We are more than willing to explain all the limitations for taxpayers who have more taxable income than $315,000. We also perform entity analysis to see if maybe switching into or out of a C-Corporation is the best move for you and your business.
Ryan Bennett, CPA