Adam Sand breaks down the QBI deduction, a 20% tax break for self-employed and small-business owners created by the 2017 Tax Cuts and Jobs Act. You lose it if you're a doctor, lawyer, accountant, or consultant. The deduction phases out above $197,300 (single) or $394,600 (married), and high earners face wage and property tests that can shrink or kill it entirely.
Normally you made $1,000 in profit, so you'd have to pay tax on $1,000. But the government says, hey, since you're running your own business and you qualify, we're going to give you a little bit of a break. So they pretend like you only made $800 instead of $1,000, and you only pay tax on $800 instead of $1,000. That is the QBI deduction. It effectively gives you 20% off of your income that you don't have to pay tax on. So it's like getting a coupon for 20% off your tax bill. Just because you work for yourself. Who doesn't like coupons? Who doesn't like discounts, right? So 20% off, heck yeah. Well, that's called the Section 199A deduction, or what's called QBI. This came about from the Tax Cuts and Jobs Act in 2017, but it was temporary. Now it is made permanent with no expiration date. But as with anything with the government, again, the Congress critters get together, they smoke something, and then they come out with these funky rules, right? So who knows, you lose the 20% discount as income increases. Also, there's an impact to business type, and there there are no changes with this. So what that means is certain businesses, specified service trader business, the SSTB rule, it means service-based business. The business relies on the skill or the reputation of one, effectively one person, or the owner of the company. And so healthcare, doctors, dentists, chiropractors, nurses, you know, people that are self-employed, attorneys, accountants, CPAs, accountants, we're part of this group, consultants. These are just some of the specified service trader business affected by this that lose the deduction. So if you're not one of those, which contractors generally are not, let's say you're crushing as a contractor and you start getting into kind of coaching other contractors, hey, here's how you do better at what you do, that would be a specified service trade or business. So the bottom line is, as QBI is, your deduction decreases as your income increases. So what are those phase-outs? If you're single, you get a full 20%. So if, let's say, I'm a consultant, or, you know, I'm an accountant, that's real life, I am an accountant, okay, if I'm single, I can get the full 20% deduction, meaning I can take 20% off my income up to $197,300, right? So almost $200,000. If I'm married filing jointly with my beautiful wife, we can earn up to basically double, almost $400,000. I start to phase out, or I fully phase out if I go over $197,300 or over $394,000, I'm fully phased out and I lose all ability to take a deduction for the QBI. When my income as a single person is over $272,000 and change and over $544,000 and change. So completely lose your deduction. So there's a lot of people out there that are crushing it. They lose that ability to take 20% off their income. That sucks, right? So the impact, if you're one of these folks, you get— don't get that deduction if you go over the limit. Non-Specified Service Trader businesses, you're still eligible if you're over those thresholds. If you have 50% of your W-2 wages, and I'll explain what that means in a minute, or 25% of W-2 wages and 2.5% of UBI or qualified property. So what does that mean? So an important part of the QBI, and you don't want to miss on this, if your income goes over those thresholds, the government puts guardrails on and says, hey, you can't take the full deduction unless you're meeting one of these criteria. So how it works is if your QBI deduction cannot be more than 50% of the total W-2 wages your business has paid. So if you earn $200,000 in profit and you only paid $40,000 in wages to your employees or yourself, you don't get the full 20%, right? Which would be $40,000. You would only qualify for $20,000 QBI, not $40,000. So the more wages you pay, the more QBI deduction you can qualify for. Again, this is people that are above those thresholds in net income. It matters because S corporations specifically, the IRS wants to fund what I call the world's biggest Ponzi scheme. They want to fund Social Security, Medicare. And so they're keeping an eye on this and saying, hey, if you're a really high income earner, you're really profitable business, you're not a specified service trade or business, but we're going to throttle your deduction if you're not paying into the system somehow in other ways. So you got to be aware of QBI deduction. If I have low income or low wages that I'm paying out, that can throttle back or reduce my QBI. The other factor is, let's say your income goes above the thresholds there's a second test that you could lean on to still get a piece of the deduction. So if 25% of your business income is W-2 wages, and then 2.5% of the original cost of your depreciable property— so if you're investing in things like buildings, equipment, machinery, then the IRS says, hey, or the rules say, hey, we're going to reward people for investing in the economy. So even if you fail the first test and 50% of your gross earnings are not going out in W-2 wages, we can still get the QBI deduction if we we have 25% of our W-2 and cap of the building. Like, let's say we have $600,000 in equipment, buildings, etc. Well, 2.5% of that would be $15,000. So the total cap on the deduction is the combination of 25% of the wages, the earnings being wages, and the 2.5% of your equipment. Kind of a complicated formula, and there's more to it than that, which is why we say, hey, either work with us or check out that workbook to kind of break it down a little bit more. But be aware that even if you're not a qualified service trader business that you could have your QBI deduction throttled back.
