The Tax Cuts and Jobs Act (TCJA) added the Qualified Business Income (QBI) deduction under Section 199A of the Internal Revenue Code (IRC).
Under Section 199A(b)(2), a taxpayer’s QBI deduction is the lesser of the following two amounts:
- 20% of QBI, or
- the greater of
- 50% of Form W-2 wages, or
- 25% of Form W-2 wages, plus 2.5% of the Unadjusted Basis Immediately After Acquisition (UBIA) of qualified property used in the trade or business.
The Section 199A deduction is calculated for pass-through entities, trusts, and individuals. A corporation cannot claim the QBI deduction in arriving at its taxable income.
Qualified business income includes the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.1 Qualified income includes income effectively connected with a trade or business within the United States and is included or allowed in determining taxable income for the taxable year.2
QBI shall not include certain items, such as capital gains and losses, interest income, wages, income that is not effectively connected income (ECI), annuities, reasonable compensation from an S corporation, and guaranteed payments from a partnership.3 QBI shall not include certain items, such as capital gains and losses, interest income, wages, income that is not effectively connected income (ECI), annuities, reasonable compensation from an S corporation, and guaranteed payments from a partnership.
Example QBI Deduction for an SSTB
Company Bravo LLC, a Florida limited liability company (LLC), operates a consulting business in Florida. The company was formed on January 1, 2023, and immediately commenced operations. The company operates from within the United States; therefore, it is engaged in a U.S. trade or business and has income effectively connected with such trade or business.
The LLC has two members and is taxable as a partnership for federal tax purposes. It operates a consulting business that provides professional services to its clients. Given those activities, the company qualifies as a Specified Service Trade or Business (SSTB) under Section 199A.
For the 2023 tax year, the company generated $100,000 of net ordinary business income, allocated 50/50 to each LLC member. The LLC paid its employees $200,000 of total wages as reported on its Form W-2s. The LLC’s UBIA amount was zero for 2023.
John Doe is a 50% member of the LLC. John receives a Schedule K-1 (Form 1065), which shows Line 1 ordinary income of $50,000, and Section 199A information as follows:
- Ordinary Business Income (Loss): $50,000
- W-2 Wages: $100,000
- UBIA Amount: $0
John Doe completes his Form 1040 income tax return and includes Form 8995 (Qualified Business Income Deduction) to report the QBI information. John’s 2023 QBI deduction is $10,000 ($50,000 times 20%), effectively reducing the net taxable income related to the business from $50,000 to $40,000.
Other Information
Taxpayers can find more information about the QBI deduction by visiting the IRS website. Please visit our YouTube channel for video tutorials on how to prepare Form 8995 and Form 8995-A for the QBI deduction.