20% Qualified Business Income Deduction

The new tax law passed at the end of 2017, Tax Cuts and Jobs Act (TCJA), includes not only a greatly reduced 21% corporate tax rate, but it also includes a significant deduction for certain businesses with what the tax code refers to as qualified business income (QBI). This qualified business income deduction (QBID) is detailed in IRC §199A, and will be valid for tax years 2018 to 2025. Qualified business income is income earned by typical pass-through entities, such as partnerships, limited liability companies, and S corporations, but also includes certain estates and trusts. Although not typically characterized as a pass-through entity, sole proprietorships are also included. Additionally, qualified income received from qualified real estate investment trusts (REITs) and publicly traded partnerships (PTPs) are also eligible for the deduction, but slightly different rules apply to this deduction, so they must be calculated separately. The deduction equals 20% of qualified business income. However, this deduction is considered a below-the-line deduction, meaning that adjusted gross income (AGI) and self-employment tax are not reduced by the deduction. Neither can net operating losses by increased by the deduction. This deduction is deducted from AGI along with the standard deduction or itemized deductions to calculate taxable income.

Qualified Business Income

Each business must qualify for the deduction, regardless of how many entities the taxpayer owns. The business must be located within the United States or Puerto Rico, but if it is located in Puerto Rico, then the business must be taxed using tax rates for individuals in the United States. QBI does not include nontaxable income nor does it include short-or long-term capital gains; interests or annuity income allocable to the business; dividends, income equivalent to a dividend, or payment in lieu of dividends; wages paid to shareholders or guaranteed payments to partners.


Qualified business income earned from REITs or publicly traded partnerships are calculated separately from other possible sources of QBI because they are not limited by the W-2 wage or qualified property limitation that limits QBI from other sources. REIT dividends generally qualify for the QBID, but that portion of the dividend resulting from a capital gain distribution or a qualified dividend are not included. Income from qualified PTP's equals the taxpayer share of qualifying QBI from the PTP plus recognized ordinary gain from the disposition of a PTP partnership interest.

QBI W-2 Wages

The QBID is limited by the W-2 wages subject to withholding, elective deferrals, and deferred compensation during the calendar year. In other words, it includes all wages subject to the Medicare tax. Moreover, only the wages for which the employer has paid the payroll tax by the 60th day after the due date, including extensions, of that return can be included in calculating QBI. This provision of the law may also affect how much shareholders of S corporations may want to pay themselves as wages, since lower wages will reduce QBI and therefore the QBID.

QBI Qualified Property

The QBID may also depend on the amount a qualified property that the business has. Qualified property includes real estate, but not land. To qualify, the property must still be used in the business during the tax year. Qualified property is defined as property held, and available for use the qualified trade or business by the end of the tax year; and the property must be used sometime during the taxable year to produce the qualified QBI; and the property must meet the depreciable test period. The depreciable test period differs from the depreciation period for the property, meaning that the depreciation period begins when the property is placed in service and ends at the later of 10 years after the property was placed in service or the final year in which it would normally be depreciated. So, for instance, computers and furniture would have a depreciation test period of 10 years, even though the depreciation period for computers is normally 5 years, and for furniture, 7 years.

The value of the qualified property equals the acquisition cost, which is referred to by the section of the tax code as the unadjusted basis immediately after acquisition (UBIA). Any immediate depreciation taken, such as bonus depreciation or a §179 deduction does not affect UBIA.

QBI Ordinary Taxable Income

The QBI is limited to 20% of ordinary taxable income as defined by this provision of the tax code. QBI ordinary taxable income equals ordinary taxable income minus net capital gains plus qualified dividends received by the taxpayer.

Specified Service Trade or Business (SSTB)

When the Republicans passed the TCJA at the end of 2017, they wanted to benefit particular businesses more than others, so they included a definition of a specified service trade or business (SSTB) as being one that will not benefit as much or will have more stringent tests to qualify for the QBID. In particular, they did not want doctors or lawyers benefiting from this deduction. An SSTB also includes a service business for investment management, trading, dealing in securities, partnership interests, or commodities. As of this writing, final regulations are not clearly delineated who will qualify as an SSTB, but architects and engineers have been specifically excluded.

Qualified Business Income Deduction Calculation

The steps involved in calculating the QBID will depend on whether the business is classified as an SSTB and on taxable income thresholds as defined by this provision of the tax code. This taxable income is simply ordinary taxable income — not the QBI taxable income defined above — before any QBID is deducted. These are the taxable income thresholds:

How the QBID is calculated depends on whether it is an SSTB and whether it's income is below the lower threshold, between thresholds, or above the upper threshold. If ordinary taxable income is below the lower threshold, then the QBID equals 20% of QBI + 20% of qualified REIT and qualifying PTP income, regardless of whether the business is an SSTB. In this case, there is no distinction between an SSTB and a non-SSTB. If an SSTB's ordinary income exceeds the top threshold, then no QBI deduction is permitted. All other cases require applying the W-2 wage and qualified property limits and possibly the phase-in rules.

The W-2 wage limitation = the lower of

  1. 20% of the taxpayers QBI or
  2.  The greater of
    1. 50% of W-2 wages
    2. 25% of W-2 wages + 2.5% of qualified property UBIA
Example: Calculating QBI When Taxpayer Income Is Less Than the Lower Threshold
QBI from business $120,000
Ordinary Taxable Income $150,000
20% of ordinary taxable income $30,000 QBI deduction  cannot exceed this.
QBI deduction from business $24,000 = 20% of QBI

For a non-SSTB with income above the top threshold, no further calculations would be needed, as this would determine the QBID. For businesses with incomes exceeding the lower thresholds, additional calculations are required for computing the QBID. Higher incomes lower the deduction. Being an SSTB also lowers the deduction.

The phase-in rules reduce the amount of the QBID available to the taxpayer if QBI is between thresholds. First, the phase-in percentage must be calculated:

Phase-In Percentage = (Ordinary Taxable Income − Lower Threshold)/Threshold Range

The threshold range equals $100,000 for MFJ and $50,000 for everyone else. For taxpayers not covered by the previous rules, additional computations are required to calculate QBID:

  1. Taxable Income in Excess of Threshold = Taxable Income − Lower Threshold
  2. Excess Percentage = Taxable Income in Excess of Threshold/Threshold Range
  3. Adjustment Amount = 20% × QBI − Amount Calculated in Step 2
  4. QBI Deduction Reduction Amount = Excess Percentage × Adjustment Amount
  5. QBI Deduction = QBI × 20% − QBI Deduction Reduction Amount
Example: W-2 Wage and Qualified Property Limitation
Given Facts
Filing Status Married Filing Jointly
QBI $120,000
Ordinary taxable income $500,000
W-2 Wages $50,000
UBIA $60,000
#1 Maximum Possible QBI Deduction $24,000 = QBI × 20%
#2 50% of W-2 wages $25,000
#3 25% of W-2 wages + 2.5% of UBIA $14,000
#4 Lesser of (#1, Greater of (#2, #3)) $24,000
#5 20% of Ordinary Taxable Income $100,000
QBI Deduction = Lesser #4 or #5 $24,000
Example: Calculating the Qualified Business Income Deduction for a Non-SSTB
Given Facts
Filing Status MFJ
Lower Threshold $315,000
Upper Threshold $415,000
Ordinary Taxable Income $412,000
QBI $200,000
W-2 Wages $50,000
UBIA $20,000
Maximum QBID = 20% of QBI $40,000
Wage Limitation = 50% of W-2 Wages $25,000
Wage and Property Limitation = 25% of W-2 Wages + 2.5% of UBIA $13,000
Greater Wage Limitation = Greater of Wage Limitation or Wage and Property Limitation $25,000
Tentative non-SSTB QBID = Lower of Maximum QBID or Greater Wage Limitation $25,000
Excess Taxable Income = Taxable IncomeLower Threshold $97,000
Threshold Range $100,000
Excess Taxable Percentage = Excess Taxable Income / Threshold Range 97%
QBID and Greater Wage Limitations Difference $15,000
QBID Reduction Amount = Tentative QBID × Excess Taxable Percentage $14,550
Tentative non-SSTB QBID = Maximum QBIDQBID Reduction Amount $25,450
20% of Ordinary Taxable Income $82,400
non-SSTB QBID = Lower of Tentative non-SSTB QBID or 20% of Ordinary Taxable Income $25,450

If this business were an SSTB, then the QBID will be much lower, if ordinary taxable income is close to the upper threshold. For SSTBs with taxable income between the thresholds, additional phase-out rules reduce the deduction further, by reducing the QBI deduction calculated previously by allowing only a percentage of the deduction:

  1.  QBI Deduction Reduction Percentage = 1 − Excess Taxable Percentage
  2.  QBI Deduction = QBI Deduction × QBI Deduction Reduction Percentage

For instance, using the information and calculations of the above example, the QBID for an SSTB is the following:

Example: Qualified Business Income Deduction for an SSTB
Tentative non-SSTB QBID $25,450
SSTB QBID Reduction Percentage = 100% − Excess Taxable Percentage 3%
Tentative SSTB QBID = Tentative SSTB QBID × SSTB QBID Reduction Percentage $764
SSTB QBID = Lower of the Tentative SSTB QBID or 20% of Ordinary Taxable Income $764

Note that the QBID is much lower than if the business was a non-SSTB, as calculated for the previous example. However, if ordinary taxable income is closer to the lower threshold, then there will not be much of a difference, which makes sense, since there is no difference between the QBID for SSTB or a non-SSTB if ordinary taxable income is below the lower threshold.

Because the new tax code uses the term pass-through entities slightly differently from other parts of the tax code, by including sole proprietorships, the new tax code groups all businesses qualifying for the QBID as relevant pass-through entities (RPEs), which includes sole proprietorships. RPEs cannot claim the QBID directly: only the business owners can claim the deduction. Thus, a partnership or S corporation will report the owners' share of QBI, W-2 wages, UBIA, qualified REIT dividends, and qualified PTP income on the schedules K-1. Only the entity determines whether the partner or shareholder is engaged in an SSTB or not: the individual owners may not make that determination. Any losses will be carried forward to reduce future QBI.

Unlike the tax cut for C corporations, the QBID will expire after the 2025 tax year. Because most states use federal AGI to determine state taxable income, the QBID will not affect state taxable income, since the QBID does not lower federal AGI.

Tax Update

Revenue Procedure 2019-38 provides a safe harbor for some interests in rental real estate, including mixed-use property, to qualify for the QBID as a trade or business. The taxpayer or RPE must hold each interest directly or through an entity disregarded as an entity separate from its owner, such as a limited liability company with a single member.

To claim the safe harbor, these requirements must be satisfied:

Owners of rental properties may still claim the QBID even if all requirements of the safe harbor are not satisfied, as long as the business would otherwise qualify under IRC §199A.