The qualifying business income deduction (QBID) lets pass-through entities take 20% off of their qualified business income (QBI); it essentially reduces the amount of QBI exposed to taxation. For the purpose of this deduction, QBI is the net amount of qualified income, gain, deduction, and loss from any qualified trade or business, including income from partnerships, S corporations (S-corps), sole proprietorships, and certain trusts.
If your pass-through entity qualifies, you can claim this deduction annually until it phases out on Dec. 31, 2025. To claim this powerful tax savings tool, attach Form 8995 or Form 8995-A to your 1040.
Key Takeaways
- All taxpayers with taxable income of $182,100 or less ($364,200 for married filing jointly, of MFJ) for 2023 can deduct 20% of QBI as a QBID
- Specified Service Trade or Business (SSTB) with taxable income between $182,100 and $232,100 ($364,200 and $464,200 MFJ) qualify for a reduced QBID based on taxable income, wages paid, and assets owned
- Non-SSTB with taxable income over $182,100 ($364,200 MFJ) receive a QBID, but it might be limited to a percentage of wages paid and assets owned
- SSTB with taxable income over $232,100 ($464,200 MFJ) do not qualify for any QBID
Who Qualifies for the Qualifying Business Income Deduction?
The overwhelming majority of small businesses are likely to be below the low threshold (threshold refers to all the net income and all the 1040 return taxable income based on your filing status). They will automatically qualify even if they are in an otherwise excluded industry, have not paid out wages, or do not own any assets.
So, your business more than likely qualifies if the total taxable income on your individual tax return is $182,100 or less ($364,200 MFJ) for 2023.
Here are more details regarding the applicable thresholds for this deduction that you should know about:
- You will qualify for the full deduction if your total taxable income is less than $364,200 if MFJ ($182,100 for all other filing statuses) on your individual returns in 2023.This is true even if your business is an SSTB.
- You will qualify for a partial deduction if you own a pass-through entity and your taxable income is greater than $182,100 but not $232,100 ($364,200 and $464,200 if MFJ) for 2023. Even SSTBs that fall in this midrange will qualify for a partial deduction.
- If you own an SSTB and your total taxable income is greater than $464,200 in 2023, then you don’t qualify for any QBID deduction.
- If you own a non-SSTB with total taxable income greater than $232,100 ($464,200, MFJ) for 2023, you qualify for a 20% QBID, but it might be limited based on the adjusted basis of assets within the business and wages paid by the business.
How to Calculate Qualified Business Income
To calculate QBI, follow this process:
- Step 1: Identify business income from Form 1040 Schedule C or E for each pass-through entity that you own.
- Step 2: Subtract 1/2 of the SE tax deducted on IRS Form 1040, Schedule 1, Line 15.
- Step 3: Subtract SE Health Insurance deducted on Schedule 1, Part II, Line 17.
- Step 4: Subtract Deductible Retirement Plan Contributions from Schedule 1, Part II, Line 16
How to Calculate the Qualified Business Income Deduction
The QBID is taken on Line 13, Form 1040, and can be taken in addition to the standard deduction or itemized deductions.
To figure QBID, you’ll need to take the lesser of:
- 20% of your qualified business income
- 20% of your taxable income minus adjusted net capital gain
Using this formula, we’ll show you how to calculate both a full deduction and a partial deduction.
QBID for Taxable Income Below the Lower Threshold
As we previously noted, if your income is below the threshold of $182,100 ($364,200 if MFJ), you’re eligible for the full deduction. When you are ready to prepare your tax return, you will figure out QBID using IRS Form 8995.
Mr. X, who owns a bookstore, is married and filing jointly for 2022. In 2022, he had the following income and deductions:
- Net income: $100,000
- Retirement plan contribution: $2,000
- Health insurance premiums: $5,000
- Self-employment tax: $14,130
- Adjustment for self-employment tax: $7,065
- Standard deduction: $27,700
After taking into account all his adjustments, his qualified business income is $85,935. We arrived at this figure by performing the following calculation:
Net income ($100,000) – retirement contributions ($2,000) – health insurance premiums ($5,000) – ½ self-employment tax ($7,065) = QBI ($85,935)
Now, let’s look at Mr. X’s ordinary taxable income. Remember, we will need this figure because QBID is 20% of the lesser of your ordinary income or your QBI.
Net income ($100,000) – retirement contributions ($2,000) – health insurance premiums ($5,000) – 1/2 self-employment tax ($7,065) – the standard deduction ($27,700) = Ordinary taxable income ($58,235)
Now that we have this information at hand, let’s figure out Mr. X’s QBID.
- Step 1: $85,935 x 20% = $17,187 (tentative QBID 1)
- Step 2: $ 58,235 x 20% = $11,647 (tentative QBID 2)
- Step 3: $11,647 < $17,187; Mr. X’s QBID for 2023 will be $11,647.
QBID for Taxable Income Above the Upper Threshold
If your taxable income is more than the annual upper threshold, it’s a little harder to figure out your QBID since it’s subject to limits. These limits include the reduction or exclusion of the QBID for an SSTB and limits based on the Form W-2 wages of a trade or business, or a combination of the Form W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property.
For an SSTB, no QBID is allowed when taxable income is above the upper threshold. For a non-SSTB, the maximum amount of QBID you can claim is still 20% of your QBI (using the calculation in our example above); however, your deduction is limited to the greater of:
- 50% of W-2 wages paid by your qualified trade or business to employees other than yourself; or
- 25% of W-2 wages paid by the qualified trade or business plus 2.5% of your share in the adjusted basis of qualifying property
If you’re following along with your tax return, you’ll need to use IRS Form 8995- A to calculate QBID if your income is in this category.
Ms. R runs a print shop. She owns the building that the print shop operates out of. She purchased the building for $300,000, which includes land with a value of $70,000. Her adjusted basis in the building is $230,000 and her basis in the land is $70,000. In preparation for filing her 2023 tax return, she wants to figure out what her QBID will be.
The following applied to Ms. R in 2023:
- Filing status: MFJ
- QBI: $400,000
- Taxable income: $500,000
- W-2 wage payments to employees: $90,000
- Adjusted basis in depreciable property: $230,000
The $70,000 basis in the land is excluded from the QBID calculation because it is not depreciable. The basis of the depreciable property to use is the adjusted basis of the property when placed in service and it isn’t reduced for depreciation claimed in later years. The adjusted basis of property is removed from the calculation on the later of 10 years since placed in service or the end of the assets MACRS recovery period.
Now that we have this information, let’s figure out Ms. R’s QBID. Remember, we still have to calculate the minimum amount of QBID, so we’ll get started with those steps:
- Step 1: $400,000 x 20% = $80,000 (tentative maximum amount of QBID 1)
- Step 2: $420,000 x 20% = $84,000 (tentative maximum amount of QBID 2)
- Step 3: $80,000< $84,000
- Note: The maximum amount of QBID 1 Ms. R can claim is $80,000 before considering other limitations.
- Step 4: $90,000 x 50% = $45,000 (limitation based on wages)
- Step 5: ($90,000 x 25%) + (2.5% x $230,000) = $28,250 (limitation based on wages and assets)
- Step 6: $45,000 > $28,250; Ms. R’s QBID for 2023 will be $45,000.
QBID for Taxable Income Between the Upper & Lower Thresholds
If your taxable income is more than $182,100 but not $232,100 ($364,200 and $464,200 if MFJ), you’ll need to use IRS Form 8995- A Part III to calculate QBID after the phase-in reduction. You can use this calculation for both non-SSTBs and SSTBs.
First, we’ll figure out the deduction for non-SSTBs.
Calculation for Non-SSTBs Within the Phase-in Range
To figure out the phase-in, you’ll need to take the following steps:
- Step 1: Figure the excess qualified business income over the maximum QBID allowed as if the taxable income was over the upper threshold.
Note: Excess QBI = 20% of QBI less the greater of:
-
- 50% of wages; or
- 25% of wages plus 2.5% of adjusted basis of depreciable assets
- Step 2: Figure your applicable phase-in percentage. Your phase-in percentage is equal to your taxable income minus the lower threshold for your filing status ($182,100 or $364,200 MFJ) divided by $50,000 ($100,000 MFJ).
- Step 3: Figure out your QBID. QBID is equal to 20% of QBI minus your phase-in percentage (calculated in Step 2) multiplied by your excess amount (calculated in Step 1).
Mrs. Z owns a widget business. She also owns the building that the widget business operates out of. She purchased the building for $500,000 and the land is worth $100,000. The adjusted basis of the building is $400,000 ($500,000 – $100,000).
In 2022, the following applied to Mrs. Z:
- Filing status: MFJ
- QBI: $400,000
- Taxable income: $394,200
- W-2 wage payments to employees: $100,000
- Adjusted basis in building: $400,000
Let’s calculate:
- Step 1: Excess amount: $30,000
- Step 1.1: Excess QBI = $400,000 x 20%= $80,000 QBI minus the greater of:
- Step 1.2: ($100,000 x 50%) = $50,000; or
- Step 1.3: (100,000 x 25%) + ( $400,000 x 2.5% ) = 35,000
- Step 1.4: $80,000 – $50,000 = $30,000
- Step 2: The phase-in percentage is equal to 30%.
($394,200 taxable income – $364,200 threshold amount) / $100,000
- Step 3: QBID is equal to $71,000.
$80,000 (20% of $400,000 QBI) minus $9,000 (30% phase-in percentage times $30,000 excess amount)
Calculation for SSTBs within the Phase-in Range
The QBID for SSTB with taxable income in the threshold phase-in range is calculated as follows.
- Step 1: Calculate the excess of your taxable income over $182,100 ($364,200 MFJ).
- Step 2: Divide the excess of step 1 by $50,000 ($100,000 MFJ) and multiply by 100%.
- Step 3: Figure your applicable percentage by subtracting the percentage from Step 2 from 100%.
- Step 4: Calculate your excess amount of qualifying income over the threshold by following the steps listed below.
- Step 4.1: Calculate the reduced amount of QBI. This equals QBI multiplied by the applicable phase-in percentage figured in Step 1.
- Step 4.2: Calculate the reduced wage amount. This amount is equal to the amount of W-2 wages you paid multiplied by phase-in percentage figured in Step 1.
- Step 4.3: Calculate the excess amount. The excess amount is equal to 20% reduced QBI minus 50% of the reduced wages.
- Step 5: Figure your phase-in percentage by subtracting the threshold amount from your taxable income and dividing this value by the phase-in range for your filing status.
- Step 6: Figure QBID by taking the 20% reduced QBI and subtracting from it the excess amount from step 4.3 multiplied by the phase-in percentage.
This calculation assumes that 50% of wages is greater than 25% of wages plus 2.5% of assets, which is the case for most businesses. If this isn’t true, the excess amount calculated in Step 4 must be adjusted accordingly.
Mrs. Z owns a widget business. She also owns the building that the widget business operates out of. She purchased the building for $500,000, and the land is worth $100,000. The adjusted basis of the building is $400,000 ($500,000- $100,000). In 2023, the following applied to Mrs. Z:
- Filing status: MFJ
- QBI: $400,000
- Taxable income: $394,200
- W-2 wage payments to employees: $100,000
- Adjusted basis in building: $400,000
Let’s calculate:
- Step 1: $394,200 – $364,200= $30,000
- Step 2: ($30,000/$100,000) x 100% = 30%
- Step 3: 100% – 30%= 70% is the applicable percentage
- Step 4: Calculate Mrs. Z’s excess amount of qualifying income over the threshold by following the steps listed below.
- Step 4.1: reduced QBI = 400,000 x 70% = $280,000
- Step 4.2: reduced wage amount = 100,000 x 70% = $70,000
- Step 4.3: excess amount using reduced QBI and reduced wages = ($280,000 x 20%) – ($70,000 x 50%) = $21,000
- Step 5: Phase-in percentage = ($394,200 – $364,200) / $100,000 = 30%
- Step 6: QBID = ($280,000 x 20% ) – ($21,000 x 30%) = $49,700
Frequently Asked Questions (FAQs)
No, QBID does not reduce net earnings from self-employment. Similarly, the deduction does not reduce net investment income.
No, material participation is not required for the QBID. Eligible businesses with income from a trade or business may be entitled to the QBID regardless of their involvement in the trade or business.
Bottom Line
If you are looking for ways to save on your business taxes, don’t miss out on a chance to claim QBID this tax season. Potentially, you could reduce your qualified business income by 20%.
