Knowledge and Insights

The Qualified Business Income (QBI) deduction, introduced under the Tax Cuts and Jobs Act (TCJA) of 2017, stands as one of the most impactful changes for business owners in recent tax history. This provision has provided significant tax relief to many small and medium-sized businesses, but its potential expiration at the end of 2025 looms, raising questions about its future. This article aims to demystify the QBI deduction, explore who qualifies for it, and examine the potential implications of its expiration.

WHAT IS THE QUALIFIED BUSINESS INCOME DEDUCTION?

The QBI deduction allows eligible taxpayers to deduct up to 20% of their qualified business income from their taxable income. Qualified business income generally includes the net amount of income, gain, deduction, and loss from any qualified trade or business. However, it excludes certain investment-related items such as capital gains or losses, non-REIT dividends, and interest income not allocable to a trade or business.

For example, the QBI deduction can be up to 20% of:

• QBI earned from a sole proprietorship or a single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
• QBI from a pass-through business entity, meaning an S corporation, a partnership or an LLC that’s treated as a partnership for federal income tax purposes.

QBI can also include up to 20% of eligible income from publicly traded partnerships and up to 20% of eligible dividends from real estate investment trusts.

However, this article focuses specifically on QBI deductions from the more common types of pass-through businesses.

By reducing taxable income, the QBI deduction effectively lowers the overall tax burden on these entities, thereby increasing their potential for reinvestment and growth.

WHO QUALIFIES FOR THE QBI DEDUCTION?

To qualify for the QBI deduction, there are several criteria that businesses must meet:

1. Type of Business: The business must be a pass-through entity. This deduction applies to Schedule C filers (sole proprietorships and other self-employed businesses), LLCs, partnerships, S corporations, estates, and trusts. Certain rental enterprises may also qualify. C corporations do not qualify for the QBI deduction.
2. Income Thresholds: For the tax year 2024, the full 20% deduction is available to single filers with taxable income of $191,950 or less and joint filers with taxable income of $383,900 or less. If taxable income exceeds these thresholds, the deduction may be limited based on the type of business and the amount of W-2 wages paid, as well as the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business.
3. Specified Service Trades or Businesses (SSTBS): High-earning businesses categorized as specified service trades or businesses, such as health, law, accounting, and consulting, face additional limitations. For these businesses, the deduction phases out once taxable income exceeds the aforementioned thresholds.

THE IMPACT OF EXPIRATION UNDER THE TAX CUTS & JOBS ACT

The sunsetting of the QBI deduction at the end of 2025 presents a significant challenge for many pass-through business owners. The elimination of this 20% tax break could notably increase their tax liabilities, thereby reducing the amount of capital available for reinvestment and growth. This potential increase in tax burden underscores the importance for business owners to reassess their financial strategies and prepare for a different tax landscape.

However, there is a glimmer of hope. Given the current administration’s pro-business stance, there is a possibility that the QBI deduction may be considered for extension. Legislative priorities and political dynamics will play a crucial role in determining the future of this valuable tax provision. Business owners should stay vigilant and informed about any legislative developments that could impact the QBI deduction.

HOW TO PREPARE FOR THE QBI DEDUCTION EXPIRATION

With the potential expiration of the QBI deduction on the horizon, business owners must take proactive steps to prepare for possible tax law changes. Here are some key strategies to consider:

1. Consult with a Tax Expert: Engaging with a tax professional is vital. They can help you understand how the end of the QBI deduction might specifically affect your business and devise strategies to mitigate any increased tax burden. An expert will offer personalized advice tailored to your business needs.
2. Plan for Adjustments: Begin your tax planning now to address potential tax hikes. Maintain regular communication with your tax advisor to stay prepared. Strategies such as accelerating income and deferring deductions can help you benefit from lower tax rates in 2024 and 2025. Additionally, investigate other tax-saving opportunities and consider strategic changes to better position your business for future tax increases.
3. Reevaluate Your Business Structure: Assess whether your current business structure remains the most tax-efficient option. In some instances, restructuring your business might yield tax benefits under the new tax landscape post-TCJA. Explore various business structures, including converting to a different entity type, to determine the optimal strategy for your business moving forward.

The Qualified Business Income deduction has been a valuable tool for many business owners, providing significant tax savings and encouraging economic growth. As we approach the potential expiration of this provision, it is crucial for business owners to understand the implications and prepare accordingly. By staying informed and proactive, businesses can navigate the changing tax landscape and continue to thrive.

MERCADIEN: A TRUSTED PARTNER FOR TAX CONSULTING

For personalized advice and detailed planning, consulting with a tax professional is highly recommended. The QBI deduction, while complex, remains a significant opportunity for those who qualify, and understanding its nuances can lead to substantial benefits for your business.

Mercadien’s Private Company Services Group has extensive experience working with clients to assist them in navigating tax planning and other challenges over the years. Contact us today to learn more about how we can assist you and your organization and discuss how we can provide support with other matters related to your company.

DISCLAIMER: This advisory resource is for general information purposes only. It does not constitute business or tax advice and may not be used and relied upon as a substitute for business or tax advice regarding a specific issue or problem. Advice should be obtained from a qualified accountant, tax practitioner or attorney licensed to practice in the jurisdiction where that advice is sought.