Running a small business is no small feat. Between handling day-to-day operations, keeping track of expenses, and managing growth, it’s easy to miss out on tax-saving opportunities. But what if we told you there’s a tax strategy that could potentially save you up to 20% of your business income?
The Qualified Business Income (QBI) Deduction is one of the most valuable tools available to small business owners. Whether you’re a sole proprietor, partner in a business, or own an S-corp, this deduction could help you keep more money in your pocket and reinvest it into your business.
Let’s dive into how the QBI deduction works and how it can benefit your small business.
What is the QBI Deduction?
The QBI Deduction, established under Section 199A of the Tax Cuts and Jobs Act, allows eligible small business owners to deduct up to 20% of their qualified business income from their taxes. It applies to businesses that operate as pass-through entities like sole proprietorships, partnerships, S corporations, and certain trusts.
This deduction is available for the income generated by your business, and it can lower your taxable income, which, in turn, reduces your overall tax liability.
Who Can Benefit from the QBI Deduction?
The QBI deduction is designed for small business owners who operate their businesses through pass-through entities. If your business is structured as a sole proprietorship, partnership, or S-corp, you might be eligible. But even if you’re not one of those, don’t worry. Rental properties and certain investments can also qualify, so it’s worth checking to see if you can claim this deduction.
Some key points to remember:
- Eligible businesses: Must be a qualified trade or business. Certain service-based businesses (called SSTBs) such as lawyers, doctors, accountants, and consultants are subject to additional limitations.
- Income thresholds: To fully benefit from the deduction, your taxable income must be under certain thresholds. For example, for 2024, if you are married filing jointly, the full QBI deduction applies if your taxable income is below $383,900. If your taxable income exceeds this, there are additional rules that come into play.
How Does the QBI Deduction Work?
Let’s break it down using a simple example.
Meet Alex, a freelance graphic designer and owner of a small creative business. Last year, Alex’s business earned $150,000 in net income. After expenses, his QBI was also $150,000.
Since Alex’s taxable income is below the threshold of $191,950 for single filers (in 2024), he is eligible for the full 20% deduction on his QBI.
The calculation looks like this:
- QBI (business income) = $150,000
- 20% of QBI = $30,000
So, Alex could potentially reduce his taxable income by $30,000—meaning he’ll pay taxes on only $120,000 instead of the full $150,000.
What if Your Income Exceeds the Threshold?
What if your business income exceeds the thresholds for a full deduction? Don’t worry—there are still ways to maximize your savings.
Once your taxable income exceeds the set threshold, the deduction may begin to phase out. This means you’ll still be able to claim some of the deduction, but not the full 20%.
Additionally, for businesses above the income threshold, the QBI deduction calculation becomes more complex. You’ll need to factor in the W-2 wages your business pays, as well as the unadjusted basis of qualified property. But don’t let that scare you—working with a tax advisor can help ensure you’re getting the most out of this deduction.
What About Specified Service Trades or Businesses (SSTBs)?
Certain businesses that primarily rely on the reputation or skill of their owners or employees—like doctors, lawyers, accountants, and consultants—are considered Specified Service Trades or Businesses (SSTBs). These businesses face stricter limitations when it comes to the QBI deduction.
For SSTBs, the QBI deduction phases out completely once taxable income exceeds a certain threshold. However, if your business doesn’t primarily rely on your personal reputation (for example, if you run an engineering firm or a real estate business), you could still be eligible for the full deduction.
Maximizing Your QBI Deduction
If you want to get the most out of the QBI deduction, consider these strategies:
- Increase Wages: If you own an S-corp or partnership, paying out more in W-2 wages to yourself can help maximize your QBI deduction.
- Reinvest in Your Business: For businesses with substantial property, increasing your investment in qualified property could help boost your deduction.
- Monitor Your Taxable Income: Keeping your taxable income under the threshold can help you qualify for the full deduction. If you’re nearing the limit, it may be worth deferring income or accelerating expenses to keep your income below the threshold.
Is the QBI Deduction Here to Stay?
The QBI deduction is currently set to expire at the end of 2025, but there is a possibility that it could be extended or modified by future legislation. Keep an eye on any potential changes, as they may impact how this deduction works for you in the coming years.
Conclusion: A Valuable Tax Strategy for Small Business Owners
The QBI Deduction can be a powerful tool to help reduce your tax liability and put more money back into your business. Whether you’re a sole proprietor, a small partnership, or an S-corp owner, this deduction can potentially save you thousands of dollars each year.
To ensure you’re maximizing your deduction, be proactive in understanding the rules and thresholds, and don’t hesitate to consult with a tax professional who can help you navigate the complexities.
If you’re a small business owner looking to save on taxes, make sure the QBI deduction is part of your tax strategy!
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