Created by the Tax Cuts and Jobs Act (TCJA) of 2017, the QBI deduction allows certain small business owners and sole proprietors to claim up to a 20% deduction of qualified income, which can provide a much-welcome major tax break. With this deduction, you may be able to divert possible major tax payments back into your business to expand. Of course, that is only an option if you know what qualifications exist to receive the deduction. Below, we’ll delve further into what the QBI deduction is, what income qualifies, and how to claim it.

What Is Qualified Business Income?

The qualified business income (QBI) deduction, which is also known as the section 199A deduction, was introduced in the TCJA. This deduction allows for small business owners, sole proprietors, and other owners of pass-through businesses to deduct up to 20% on their qualified business income if they meet certain guidelines. For pass-through business owners, taking a QBI deduction first means calculating qualified business income. The deduction applies only to your QBI, which generally refers to your business’s net income. The IRS defines qualified business income as the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. What doesn’t qualify as QBI is just as important for you to identify in order to determine whether you can take the deduction. Some items not considered qualified business income include:

Capital gains and lossesInterest incomeW-2 incomeSpecific wage and payments made to partners or corporationsDividends

W-2 wages or salaries paid to employees and the unadjusted basis immediately after acquisition (UBIA) also act as limitations to what you can deduct. The UBIA refers to the cost of property owned and recently purchased by the business.

Can You Claim a Qualified Business Income Deduction?

The QBI deduction is available for individuals who use the pass-through process to report business income on their personal tax returns and be taxed at individual income tax rates. These entities include:

Sole proprietorshipsPartnershipsS corporationsLimited liability corporations (LLCs)

However, there are other specific limitations and qualifications that afford or deny pass-through entities the ability to take up to 20% deduction. Finding out what you can claim as a QBI deduction means identifying your operation as a qualified business, under or at the threshold amount, and considering other income factors such as a real estate investment trust (REIT) and UBIA.

Threshold Amounts

One of the most important qualifiers of receiving the QBI deduction is the threshold income amounts set by the IRS each year. For example, in tax year 2021, you may qualify if your taxable income is at or below $329,800 for married joint filers, $164,925 for married separate filers, or $164,900 for single filers. There are also phase-out levels for qualifying for the QBI deduction for each filing status. You may still be eligible to receive a deduction of up to 20% of your income that doesn’t exceed $429,800 for married joint filers, $214,925 for married separate filers, and $214,900 for single filers.

Qualified Trade or Business

The IRS defines a qualified trade or business as any 162 section trade or business, but three exceptions to the rule exist.

A business operating as a C corporation is ineligible as the corporation’s income is taxed apart from its owner.Services you carry out as an employee are ineligible.Specified services trades or business (SSTB) that exceed the income threshold are ineligible to receive the deduction.

An SSTB’s prime asset is the skill and reputation of the employees or owner, who conducts business in the fields of health, law, performing arts, consulting, trading, or athletics to name a few. However, an SSTB that makes at or below the threshold amount can take the deduction up to 20%.

How To Claim a Qualified Business Income Deduction

Let’s say you are eligible to receive the QBI deduction after meeting the necessary guidelines and income thresholds. You now have two different processes, depending on the complexity of business operations and total taxable income.

Form 8995

The IRS Form 8995 is best for simplified tax returns and a straightforward QBI deduction for a business owner. You can use this to figure out your deduction if you have QBI; you are not a patron of specific cooperatives; and you meet the threshold limits of $164,900, $164,925, or $329,800 depending on your filing status.

Form 8995-A

Use this form if you are involved in a more complex business situation, such as an SSTB, if taxable income is over the threshold, or if you or your business are patrons of specific cooperatives. Before starting Form 8995-A, you’ll want to complete an applicable Schedule A, B, or C on Form 1040 depending on your business situation. Schedule A reports itemized deductions, Schedule B reports interest and ordinary dividends, and Schedule C reports profit or loss for sole proprietors.