The Tax Cuts and Jobs Act (TCJA) offers a generous tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction usually applies to income from partnerships, sole proprietorships, limited liability companies (LLCs), and S corporations. It can equal at most 20% of QBI, but once taxable income surpasses $315,000 for married couples filing jointly or $157,500 for other filers, a wage restriction begins to phase in.
Full vs. partial phase-in
When the wage restriction is completely phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally cannot surpass the greater of the owner’s share of:
- Half of the amount of W-2 wages paid to employees during the tax year, or
- The total of 25% of 2.5% of the charge of qualified business property (QBP plus W-2 wages.
When the wage restriction applies but is not yet wholly phased in, the amount of the limitation is reduced, and the final deduction is intended as follows:
- The difference between taxable income and the relevant threshold is divided by $100,000 for joint filers or $50,000 for other filers.
- Multiply the resulting percentage by the fully wage-limited deduction and the difference between the gross deduction.
- Subtract the result from the gross deduction to ascertain the final deduction.
Let’s say Albert and Lisa have a taxable income of $600,000. The revenue includes $300,000 of QBI from Albert’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but, the wage restriction applies in full because the married couple’s taxable income surpasses the $415,000 peak of the phase-in range for joint filers. For this circumstance, computing the deduction is relatively straightforward.
The first possibility for the wage limit calculation is $50,000 (half of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So, the wage limit — and the deduction — is $50,000.
What if Albert and Lisa’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:
($400,000 taxable income – $315,000 threshold)/$100,000 = 85%
The couple must first figure 85% of the difference between the fully wage-limited deduction of $50,000 and the gross deduction of $60,000 to find the amount of their deduction:
($60,000 – $50,000) × 85% = $8,500
Subtract the 8,500 from the $60,000 gross deduction for a concluding deduction of $51,500.
That’s not all
An additional constraint may apply: for income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income fell inside the relevant income range and is eliminated if income surpasses it. If you have questions concerning the QBI deduction or want to learn whether your business is a specified service business, please contact us.
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Ben R Shull CPA LLC provides clients with tax, transaction, and advisory services. The insights and quality services we deliver help lead our clients through the next generation of changes, and accelerate growth while reducing risk. CPA Katy, TX.