The Tax Cuts and Jobs Act created a brand new, seemingly uncomplicated deduction called the Qualified Business Income deduction.
In theory, this new tax deduction should be a simple 20% deduction that business owners receive on their qualified business income. Assuming the business owner stays below the phase out threshold, they’ll get to enjoy the tax benefits provided by the new law.
As you probably know by now, that’s not how the IRS or the federal government works.
The Qualified Business Income deduction is no different. On the surface it seems like a pretty simple deduction but it became very complicated when groups of business owners (in favor and out of favor) were added to the equation.
Let’s begin with a very simple premise. The QBI deduction only works for you if you’re a pass through entity. If your business is structured as a C Corporation, you automatically disqualify yourself from the 20% deduction.
If your pass-through business is an in-favor business and it qualifies for 20% tax deduction on qualified business income, you benefit at all times. This includes being above, below, or in the expanded wage and property phase-in range.
On the other hand, if your business is a specified service trade or business (doctors, lawyers, accountants, actors, athletes, traders, etc.) it is in the out-of-favor group and you benefit only when you are in or below the phaseout range.
Let’s look at a quick example.
You operate a proprietorship, file as a single taxpayer with $135,000 of taxable income, and have qualified business income of $120,000. Your new 20 percent tax deduction is $24,000 ($120,000 x 20 percent).
Once your taxable income exceeds the threshold amounts above, you arrive in one of the four possible categories below:
- Phase-in range for a non-specified service trade or business
- Phaseout range for a specified service trade or business
- Above the phase-in range for an in-favor non-specified service trade or business
- Above the phaseout range for an out-of-favor specified service trade or business
If your taxable income is going to be above the threshold amounts that trigger the phase-in or phaseout issues, you should be spending time considering the implications you’re facing and how to best find yourself below the threshold. This is where planning using a multiple LLC structure can really benefit you.