If you are self-employed or work as an independent contractor, tax deductions are really important for lowering your tax obligation. One such deduction that can be of tremendous help is the qualified business income deduction also known as QBI. The QBI deduction is available for small business owners and self-employed and allows them to deduct up to 20% of their qualified business income from their taxes. Read on to learn how the QBI works and how it can help you save money on your taxes.
Deduction for Qualified Business Income
The qualified business income deduction is for self-employed and small business owners. In order to claim the deduction, you must have pass-through income, meaning the income is passed directly from the business entity to you. You will pay taxes according to your tax bracket, as opposed to corporate rates. In addition, you must meet income guidelines.
For single filers, income levels must not exceed $160,700 and for joint filers $321,400 for 2019. Income limits increased slightly for the tax year 2020. Taxpayers whose income exceeds the limit can still qualify for a partial deduction.
The qualified business income deduction is a below the line deduction, although not quite an itemized deduction. The QBI works to reduce your taxable income but not your adjusted gross income. It allows pass-through businesses like S-corps to deduct up to 20% of their own net income from their pass-through income. This reduces their marginal tax rate.
In order to claim the QBI deduction, your business must be set up as a pass-through entity. This includes:
- Sole Proprietorships
- Partnerships
- S Corps
- LLC (limited liability companies)
Calculating QBI
When claiming the QBI, you first need to calculate your taxable income. If you have multiple streams of income, you can combine them. This includes W-2 wages as well. If you have established that your income qualifies, and you are below the income limits, you are allowed to take the full 20%. However, if you are over the income limits, you will have to calculate your limitation.
To calculate the limitation, you will have to factor the total wages paid as well as the qualified property. Qualified property is defined as tangible property that is personal or real that is subject to depreciation. This does not apply to land. For higher-income earners, the limitation is either based on 50% of W-2 wages or 25% of W-2 wages and 2.5% of the unadjusted basis for all qualified property. You are allowed to take whichever method delivers a greater deduction. If your combined QBI results in a loss, this loss can be carried over into the next year.
Qualified Business Income Deduction for Rental Property
Some businesses can’t claim the QBI. This includes specified services trades or businesses, or SSTBs. Healthcare, law, and accounting firms are examples of SSTBs. Fortunately, most short term rental hosts don’t fall into this category. In fact, most hosts usually qualify, so they can deduct up to 20% of their net rental income from their taxes with the QBI deduction. Best of all, you can still deduct your regular rental-related business expenses.
The IRS considers rental income as passive so it usually doesn’t qualify for QBI. This applies if your property is rented for a year or more and there is little interaction between landlord and tenant. However, Airbnb hosts can usually avoid this label, as long as their rental activities constitute a business. In order to qualify for the qualified business income deduction, you must meet these.
QBI Requirements
- Minimum of 250 hours of rental service per year.
- Detail records of expenses, income, and transactions must be kept for each property.
- Records of services performed must be kept. This includes maintenance, buying supplies, and other property management activities.
In addition, your business must qualify as a trade or business. In other words, you intend to make a profit with your rental. Some exclusions apply. For example:
- Long term rental properties that are rented out for a year or more
- Owner-occupied properties, even if it is part-time. This applies to vacation homes.
- Rentals located outside of the US
- Triple Net leases where the tenant pays taxes, insurance, and maintenance in addition to rent
- Land leases
QBI Deduction Worksheet
The tax cuts and jobs act brought about some changes to the tax code, including the 20% reduction for qualified business income. Like most provisions of the TCJA, the QBI is set to expire in 2025, unless it is extended. We understand that the QBI can be confusing, especially if you are trying to calculate your limitations.
Using a QBI worksheet can help you determine your business’s eligibility. The IRS provides free worksheets to help you prepare for taxes on their website.
Need help filling out the worksheet? A tax advisor who specializes in the Sharing Economy can be of great assistance when it comes to filling out the worksheet and calculating your limitations.
Maximize Your Deductions
Do your rental activities qualify you for the qualified business income deduction? Find out today. Schedule a strategy session with a Shared Economy tax expert. We understand the Sharing Economy so we know how to make tax deductions work for your business. Shared Economy tax prep services can help you save time and money. For more tax tips, subscribe to our newsletter below.