Optimizing the Qualified Business Income Deduction
Posted by Brian Kern on March 11, 2024
Optimizing the Qualified Business Income (QBI) deduction represents a strategic tax-saving opportunity, particularly as its availability is set to terminate after 2025. Harnessing this deduction efficiently becomes imperative for eligible businesses. The QBI deduction, applicable at the owner level, constitutes up to 20% of the qualified income generated from various business structures, including sole proprietorships, single-member LLCs treated as sole proprietorships, partnerships, and S corporations.
Defined as qualified income and gains from eligible businesses, QBI undergoes reductions associated with specific deductions, including contributions to self-employed retirement plans, deductions for self-employment tax, and self-employed health insurance premiums. Notably, the QBI deduction does not influence net earnings for self-employment tax computation or investment income for the 3.8% net investment income tax imposed on higher-income individuals.
However, limitations on the QBI deduction emerge at higher income thresholds. Commencing in 2024, these limitations become applicable when taxable income exceeds $191,950 for individuals ($383,900 for married joint filers), with full phase-in occurring when income surpasses $241,950 or $483,900, respectively. In cases where income surpasses the fully-phased-in thresholds, the QBI deduction is subject to limitations based on either a percentage of W-2 wages or a combination of W-2 wages and the unadjusted basis of qualified property.
The latter limitation is designed to favor capital-intensive businesses, such as those in hospitality or manufacturing, by considering the acquisition cost of depreciable tangible property used in income generation. Additionally, the QBI deduction cannot exceed 20% of taxable income before considering the deduction itself and before factoring in any net capital gains.
Certain businesses, termed specified service trade or businesses (SSTBs), face further constraints. The QBI deduction for SSTBs begins to phase out at the same income thresholds, with complete phaseout occurring beyond the higher thresholds. Moreover, electing to aggregate multiple businesses can impact the deduction, potentially allowing for a larger deduction than if businesses were considered separately.
Furthermore, decisions regarding deductions such as first-year Section 179 depreciation and 60% first-year bonus depreciation could influence the overall tax outcome, as they reduce both QBI and taxable income. Hence, strategic navigation of depreciation write-offs becomes essential to optimize the QBI deduction.
Given the looming expiration of the QBI deduction after 2025, strategic utilization of this tax benefit for 2024 and 2025 is advisable. Professional assistance can be invaluable in maximizing this deduction within the prevailing regulatory framework.
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Brian is an experienced tax professional who devotes his professional time to structuring tax strategies in the areas of compliance, consulting, planning, and transactional work. He works closely with a broad range of high-net-worth individuals and privately owned commercial businesses, specializing in the areas of energy, financial institutions, professional services, and real estate, and serves as the tax practice leader for our manufacturing niche. Brian joined Lumsden McCormick in 2006 as a staff accountant; he was named partner in 2018.