The QBID was designed as a tax break for small businesses, so there are some limitations on who can take the deduction. Higher income taxpayers must qualify in order to benefit from this tax break. For those taxpayers with taxable income before the QBID less than $157,500 (single filers) or $315,000 (married filers), the following limitations do NOT apply.
However, if your taxable income exceeds those amounts, you need to consider the following limitations:
- Specified Service Trade or Business Limitation
- Wage and Property limitations
- 50% of Employee W-2 wages (not including management fees), or
- 25% of Wages plus 2.5% of cost basis of property subject to depreciation
Specified Service Trade or Business Limitation (SSTB)
As a reminder from Part I of our 20% QBID discussion, an SSTB is “any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investment managers and traders, or any trade or business where the principal asset of such trade or business is the reputation or skill of its employees (not including engineers and architects).”
If your business is an SSTB and your taxable income is below $157,500 (single filers) or $315,000 (married filers) the limitations do NOT apply. If your business is an SSTB and your taxable income exceeds $207,500 (single filers) or $415,000 (married filers), your deduction for qualified business income is $0. If your business is an SSTB and your taxable income falls between these amounts, the QBID is reduced on a pro rata basis.
For example, a single taxpayer with total taxable income before the QBID of $182,500 is one half of the way through the phase in level. You will be able to deduct one half of the otherwise computed QBID.
Wage and Property Limitations
The second limitation applies to all qualifying business income when taxable income before the deduction exceeds the phase in amounts ($157,500 for single or $315,000 for married).
To apply this limitation, the business must first determine W-2 wages paid to employees and then allocate this amount to each owner of the business using the same allocation percentage used to allocate the wage expense. The second calculation the business must make is unadjusted basis of all business assets currently being depreciated, which is then allocated to each owner based on the same allocation method for allocating depreciation expense.
Using these two amounts, the taxpayer must compare:
- 50% of allocated wages, and
- 25% of allocated wages plus 2.5% of allocated unadjusted property basis
The larger of these two numbers represents the maximum amount allowable as a QBID for taxable income exceeding the phase out levels of $207,500 for single filers and $415,000 for married filers. So, if the larger of these two amounts is less than your tentative QBID, your deduction is limited to the amount of the wage and property limitation amount calculated above. Again there is a pro rata calculation of the allowable QBID for taxpayers between the phase in and phase out levels. This calculation gets a little trickier as you need to compare the full QBID with the amount of the fully reduced QBID and calculate the reduction on a pro rata basis.
Examples of Wage and Property Limitations
A married taxpayer has taxable income before QBID of $500,000. QBI from her business is $300,000, resulting in a tentative QBID of $60,000 ($300,000 x 20%). Allocable employee wages are $40,000 and allocable unadjusted basis of property is $100,000. The wage limitation is $20,000 ($40,000 x 50%). The combined wage and property limitation is $12,500 (($40,000 x 25%) + ($100,000 x 2.5%)). The greater of the two limitations is $20,000, so her QBID is reduced from $60,000 to $20,000.
Now consider the same example, except the taxpayer’s income is between the phase in and phase out amounts instead of above the phase out amount. A married taxpayer has taxable income before QBID of $375,000. QBI from her business is $300,000, resulting in a tentative QBID of $60,000 ($300,000 x 20%). Allocable employee wages are $40,000 and allocable unadjusted basis of property is $100,000. The wage limitation is $20,000 ($40,000 x 50%). The combined wage and property limit is $12,500 (($40,000 x 25%) + ($100,000 x 2.5%)). The greater of the two limitations is $20,000. The potential reduction in the QBID if the taxpayer’s taxable income exceeded the phase out amount of $415,000 would be $60,000 less $20,000 or $40,000. With taxable income before the QBID of $375,000, the taxpayer has exceeded the income threshold by $60,000, which is 60% of the full $100,000 maximum phase-in level. Next, we multiply the potential reduction of $40,000 by 60% to arrive at the actual reduction of $24,000. Therefore, the actual QBID is $36,000 ($60,000 less the reduction of $24,000).
For an even more challenging scenario, consider what happens if you have multiple businesses, some of which are SSTB, and others with various levels of W-2 and unadjusted basis limitations. The limitations are applied both at the business level and again at the taxpayer level, which would create a very complex calculation.
In our next and final segment on the QBID (for now), we will explore how to maximize the deduction.