The Tax Cuts and Jobs Act provided non-corporate taxpayers (e.g., S-corporations, partnerships, limited liability companies, and sole proprietorships) a new deduction that is claimed on individual income tax returns. Calculation of this deduction is complex. In short, the Act provides a 20% deduction for qualified business income (QBI). This 20% deduction is limited by particular thresholds. However, these limitations come into effect only when a certain amount of taxable income is reached on the individual tax return. Moreover, special rules apply to specified service businesses.
Specifically, the Act allows individuals and certain trusts to potentially deduct 20% of QBI as a deduction from taxable income (the deduction will be presented after a taxpayer’s adjusted gross income so as not to affect other items that are directly tied to a taxpayer’s adjusted gross income). QBI has a broad definition and is effectively connected to a non-corporate entity’s business activities within the United States. However, QBI does not include investment items such as dividends, interest or capital gains/losses.
If the individual's taxable income exceeds $157,500 (or $315,000 for a joint return), the 20% deductible amount could be further limited. The Act generally limits the deduction to the lesser of:
1. 20% of the taxpayer’s qualified business income for the trade or business; or
2. the greater of: (a) 50% of W-2 wages from the business; or (b) 25% of W-2 wages from the business plus 2.5% of the unadjusted basis of all qualified business property.
As mentioned above, the deduction excludes income earned through “specified service activities.” A “specified service activity” is any venture where the principal asset sold is based on an employee or owner’s reputation or skill (e.g., health, law, accounting). The Act allows taxpayers that earn income from a specified service activity to still claim this deduction if their taxable income falls below $207,500 for a single taxpayer ($415,000 for a married filing jointly taxpayer).
While the computation is complex and further limitations and rules not outlined above may apply, the deduction could provide a large reduction in taxes to taxpayers that qualify.