The landscape · Self employed and owners
The qualified business income deduction
The qualified business income deduction lets an owner of a pass through business deduct up to 20 percent of that business income on the personal return, with limits that tighten at higher incomes.
Who this exists for. This exists for a sole proprietor, partner, S corporation owner, or landlord with business income that flows onto a personal return. Ticks that show it: I earn money on my own (freelance, gig, side work); I own a business with revenue; My household income is well above average.
How it works
The deduction is this year's official qbi deduction percent (not yet verified here; see the official source below) percent of qualified business income, capped at 20 percent of taxable income before the deduction minus net capital gains. Below a taxable income line of this year's official qbi threshold single (not yet verified here; see the official source below) for a single filer or this year's official qbi threshold married (not yet verified here; see the official source below) for a joint return, the deduction is simply the percent. Above that line, two limits phase in: the deduction cannot exceed the greater of 50 percent of W2 wages paid by the business or 25 percent of wages plus 2.5 percent of the cost of its buildings and equipment, and a specified service business such as health, law, accounting, consulting, or financial services loses the deduction entirely once income passes the top of the phase in range. Wages the owner pays themselves from an S corporation are not qualified business income but do count as W2 wages for the limit.
What it gives
A plain 20 percent deduction with no spending required, for most small businesses under the line.
Rental income from a real estate business can qualify under conditions the IRS lists.
It stacks with the standard deduction, since it is taken on the return rather than on Schedule C.
What it costs, or where the catch is
Service businesses lose it entirely above the phase in range, which is a cliff for a high earning consultant or doctor.
Above the line the wage and property test can cut a solo business with no employees to a small deduction.
The calculation runs to several worksheets and interacts with retirement contributions and the half of self employment tax deduction.
A worked example
Dmitri is a plumber filing jointly with $110,000 of qualified business income and taxable income of $95,000 before the deduction. Twenty percent of $110,000 is $22,000, but the cap is 20 percent of his $95,000 taxable income, which is $19,000. His deduction is $19,000. At a 12 percent rate that saves $19,000 times 0.12, about $2,280 of federal income tax, with no change to his self employment tax.
Where it goes wrong
The common miss is a service business owner near the income line who does not know a few thousand dollars of extra income can erase the entire deduction.
Who confirms it for you
For your own numbers, a CPA or enrolled agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.
The official source
IRS: Qualified business income deduction. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.
Ask about The qualified business income deduction
A model reads this page and answers from it. It will say when the answer is not on the page. Education, not personalized advice.
Nearby doors
- After tax contributions and the mega backdoor Roth
This exists for a worker whose plan allows after tax contributions above the deferral cap and allows them to be moved into a Roth account.
- Nonqualified deferred compensation
This exists for higher earners, usually executives and senior staff, whose employer offers a plan to defer salary or bonus beyond what a 401(k) allows.
- The health savings account
This applies when a person is covered by a qualifying high deductible health plan and has no other disqualifying coverage, which opens the door to a health savings account.
- The traditional IRA and the deduction phase out
This exists for anyone with earned income who opens an IRA on their own, and especially for a worker who also has a plan at work, since that changes whether the contribution is deductible.
- The Roth IRA and its income phase out
This exists for anyone with earned income below the Roth income lines who wants an account where qualified withdrawals come out tax free.
- The backdoor Roth and the pro rata rule
This exists for a person whose income is above the Roth IRA phase out and who has no pretax money in any traditional IRA.
Education, not advice. Wealthy Habitat explains how rules work and never recommends what to do with your money. The No Advice Disclosure.