The Tax Cuts and Jobs Act (TCJA) created a major new tax deduction for self-employed individuals and owners of pass-through entities like partnerships, S corporations and limited liability companies (LLCs). Effective for 2018 through 2025, the deduction for “qualified business income” (QBI) can be as high as 20%.

However, these deductions are reduced or eliminated for certain taxpayers, depending on the amount of QBI and the nature of the business activity and, in some cases, wages paid to employees and the value of business property. QBI is generally defined as your net income from the business less amounts in the nature of compensation.

Starting point: The TCJA divided eligible taxpayers between those that provide personal services and those that do not. The “specified service trade or business” (SSTB) group includes attorneys, physicians, consultants, athletes, financial planners, accountants, stockbrokers and others who typically offer services to the public (but engineers and architects are specifically excluded). Then the following rules are applied.

  • If your income on your 2021 return is no more than $164,900 as a single filer or $329,800 as a joint filer, you are entitled to the full 20% QBI deduction—no questions asked. It does not matter if you are in the SSTB group or not.
  • If your income on your 2021 return exceeds $214,900 as a single filer or $429,800 as a joint filer, you get no deduction if you are a SSTB owner. For other owners above these thresholds, your deduction is limited and possibly eliminated.
  • If your income on your 2021 return falls between the thresholds stated above, your deduction may be reduced, regardless of whether you are a personal service provider or not.

Note that these thresholds are indexed for inflation. For simplicity, we have referred to the figures for 2021.  If you are reading this in later tax tears, those figures will need to be adjusted.

Key point: Assuming you are a personal service owner who files a joint return, the amount of your QBI is phased-out on a pro-rata basis until it disappears completely when total taxable income exceeds $429,800. For other taxpayers above the upper threshold, the deduction is limited by the greater of either (1) 50% of the wages the business pays its employees or (2) 25% of wages plus 2.5% of the basis of the qualified property owned by the business. After comparing this limited deduction to the 20% deduction of QBI, you are entitled to deduct the smaller of the two.

Suffice it to say, the calculations involving the QBI deduction for sole proprietors and owners of pass-through entities are often complex. In addition, depending on your situation, it may make sense to file separate returns if you are married, due to the way the tax brackets work. Of course, filing separately will have other repercussions and may actually increase your overall tax.

Final point: Obtain professional tax assistance for your situation. Remember that this deduction is scheduled to end after 2025.