QBI Deduction for Small Business: What it is and How to Claim It

Overview of the Qualified Business Income (QBI) Deduction in 2020

In December 2017, Congress created a special tax treatment for pass-through companies (subchapter S corporations, LLCs, partnerships, and sole proprietors). We wrote an initial post on how QBI reduces taxes for pass-through entities.

Many owners of pass-through entities can reduce their taxes with this regulation.

What is QBI?

QBI is the net amount of the company’s loss from a trade or business in the U.S. The IRS does not allow you to include some items in computing your QBI, including:

  • Capital gains and losses
  • Certain dividends and interest income
  • Reasonable compensation received by S corporation owner-employees and guaranteed payments received by partners
  • Charitable contributions paid by the entity

The IRS also requires owners of pass-through entities to reduce their QBI by excluding some deductions connected to having business income, which includes:

  • Deduction for one-half of self-employment tax
  • Deduction for self-employed SEP, SIMPLE, or other qualified retirement plans
  • Self-employed health insurance deduction

The 20% deduction available in addition to itemization

Owners of pass-through entities subtract the QBI deduction on their individual income tax return after the calculation of adjusted gross income (AGI).

With this regulation, individuals with pass-through income can deduct 20% of their QBI from their taxable income. Pass-through entity owners can take the standard deduction, and still claim this 20% deduction.

Calculating QBI

After you have calculated the amount of income you can classify as QBI, you then apply the rules related to the regulation’s income limits.

If the IRS classifies your business as Specified Service Trade or Business (SSTB), the agency limits the amount QBI income you can deduct. You can deduct 20% of your QBI income if you are a single filer with an AGI below certain limits.

For the tax year 2019, owners of SSTBs can take the full QBI deduction if they are a single filer with an AGI less than $160,700 or a joint filer with income less than $321,400. Owners of SSTBs with incomes above these amounts will see a phased reduction on their allowable QBI.

If the owner is a single filer with income greater than $210,700 or married with income greater than $421,400, they are not eligible for this deduction.

Visit our past post on the QBI limit to get more info on SSTBs and income limits.

How to Claim the QBI Deduction on Your Tax Return

Step 1: Calculate your QBI

To start the process of calculating your QBI, look at your Schedule K-1 and the related information.

Step 2: Find your AGI

Next, determine your taxable income. To get this figure, go through the first eight lines of your Form 1040 and find your AGI. If you use an online tax-filing service, the system will help you calculate this figure.

Step 3: Use Form 8995 or 8995-A

If you are claiming the QBI deduction for 2019, you will need to fill out Form 8995, Qualified Business Income Deduction Simplified Computation, or Form 8995-A, Qualified Business Income Deduction.

Use Form 8995 if your taxable income is less than the income threshold.

Fill out Form 8995-A if your taxable income is more than the income threshold. Attach whichever form you use to your personal tax return.

Both of these forms take you through the process of adding up your qualified business income. The calculations are relatively straightforward.

Claiming the deduction for previous years

Congress created the QBI deduction in the 2017 tax reform legislation. This deduction was first available for 2018 taxes. If you were eligible for the QBI deduction for the tax year 2018 and you did not claim it, you will need to file (Form 1040X) an amended return.

Please contact us if you need help claiming your QBI deduction.

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