The Tax Cuts and Jobs Act created a new income tax deduction for producers, Section 199A Qualified Business Income (QBI) Deduction, sometimes referred to as the “pass-through deduction.” The deduction is generally 20 percent of qualified business income but may be limited by your taxable income or wages paid. It is available to sole proprietors, partnerships, limited liability companies and S corporations.
The deduction is claimed on an individual’s income tax return, not the business tax return. It reduces taxable income, but not adjusted gross income and is available even if the taxpayer takes the standard deduction. This means it reduces income tax, but not the amount of self-employment tax.
Qualified business income is the net amount of qualified items of income, gain, deduction, and loss relating to any qualified trade or business. This means if the owner has separate businesses for the cattle, hay and row crops, he must combine the items from each operation to determine the net income from operations. QBI does not include any item of capital gain or loss, dividends, interest income unless it is allocable to the business, and reasonable compensation paid to employees or guaranteed payments to owners.
As an example, assume a husband and wife have $60,000 of W-2 wages from off-farm jobs and have $40,000 of net income from the cattle operation. They would owe $4,590 for FICA ($60,000 * 7.65%) as employees and $5,652 for self-employment tax ($40,000 * 92.35% * 15.3%). Their taxable income would be $65,174 ($100,000 – 2,826 (1/2 of SECA) – 24,000 (standard deduction) – 8,000 (QBI deduction)). Their income tax would be $7,440 leaving them with $82,318. Since the marginal tax rate for this example was 12%, the QBI savings was $960 ($8,000 QBI deduction * 12% marginal income tax rate).
*Under the new Tax Cuts and Jobs Act the standard deduction for a married couple filing jointly is $24,000, but the personal exemption has been eliminated. The new tax rates are 10% for the first $19,050, 12% for income above $19,050 and less than $77,400, and 22% for income above $77,400 but less than $165,000. The maximum individual rate is 37%.
The deduction may be limited by your taxable income. As for charitable deductions which can only be deducted up to 50% of your income no matter how large the contribution, the QBI deduction is limited to 20% of your taxable income plus 20% of any qualified cooperative distributions.
As an example, a husband and wife had taxable income of $85,000 which included $15,000 of capital gain on the sale of land. Other items include a net loss of $5,000 on the cattle operation, a net gain of $25,000 on the hay operation and a $3,000 patronage payment.
The deduction (1) is the lesser of (i) the combined qualified business income or (ii) 20% of the excess, if any, of taxable income minus (a) capital gains minus (b) the taxpayer’s qualified cooperative dividends plus (2) the lesser of (A) 20% of the aggregate amount of qualified cooperative dividends or (B) the taxpayer’s taxable income in excess of capital gains.
If the taxpayer is above the threshold amount, $157,000 for single or $315,000 for married filing jointly, the deduction may be limited by the amount of wages paid by the business. The deduction is limited to the greater of (a) 50% of W-2 wages relating to the qualified trade or business or (b) 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property, essentially the purchase price of the depreciable equipment still in use and less than 10 years old.
We wanted to make you aware of the new deduction and the information you need to calculate it. Hopefully you will use an accountant or software to calculate the amount of the deduction.
*This is for information purposes only and is not a substitute for legal advice or recommendations.
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