Each year we find many owners of sole proprietorships, partnerships, S corporations and some trusts have the opportunity to increase the amount of Section 199A 20% QBI deduction they will qualify for in 2023.
The 20% qualified business income (QBI) deduction is a significant tax benefit to many owners of pass-through entities. However, high-income owners of specified service trades or businesses (SSTBs) are not eligible for the 20% QBI deduction - their 1040 taxable income exceeds the annual Section 199A QBI 20% deduction income limit. These SSTBs include the fields of health, law, consulting, athletics, financial services and other businesses in which the principal asset is the reputation or skill of one or more owners or employees.
Powerful tax planning opportunities exist allowing many taxpayers to reduce their taxable incomes or increase their QBI to levels such that they can go from little or no Section 199A deduction to a significant deduction. Short-changing yourself from maximizing every dollar of the Sec 199A 20% QBI Deduction that you deserve can be expensive - and unnecessary.
In 2023, taxable income limits for couples with SSTB businesses filing Married Filing Jointly (MFJ) looking to qualify for 100% of the 2023 Sec 199A QBI 20% Deduction is $364,000. For single filers with an SSTB business looking to qualify for 100% of the 2023 QBI 20% Deduction, the personal taxable income limit is $182,100.
Couple filing jointly in the $364,000 - $662,200 income range will be subject in a phaseout, as will single filers in the $182,100 - $232,100 income range.
Do you have a self-rental or other rental income? Self-rental and other rental income qualifies for the deduction. A QBI deduction is calculated for each of these activities, and is then combined. Once a combined QBI amount is calculated it is then subject to an overall limitation of 20% of taxable income after subtracting net capital gains.
Do you have a business that sells products and also provides services that would qualify as an SSTB? Regulations provide that a trade or business with $25 million or less in gross receipts for the tax year would not be considered an SSTB if less than 10% of the gross receipts are attributable to SSTB activities.
The following examples illustrate application of the de minimis SSTB rule.
Example 1: ABC Company is an S corporation that sells computer products and provides information technology consulting services. For the 2023 tax year, ABC’s computer products sales were $ 150,000 and its consulting service revenue was $ 20,000. ABC maintains one set of books and records for both divisions and otherwise treats the two divisions as one business. In this case, all of ABC’s income is considered SSTB income for QBI deduction purposes because more than 10% of the gross receipts are derived from an SSTB source.
Example 2: Assume the same information as in Example 1, except that ABC’s consulting service revenue was $12,000 for the tax year. In this situation, none of ABC’s income is considered SSTB income for QBI deduction purposes because less than 10% of the gross receipts are derived from an SSTB source.
Example 3: Again, assume the same information as Example 1, except that ABC maintains separate books and records for the computer products sales and consulting services divisions, the divisions have separate employees, and the two divisions qualify as separate trades or businesses. In this case, the income derived from the computer products sales trade or business is considered non-SSTB income, and what is derived from the consulting trade is treated as SSTB income.
For a part of the business to be considered a separate trade or business certain facts and circumstances must apply and Section 162 and Section 199A trade or business requirements must be satisfied. One requirement is that a complete and separable set of books and records must be maintained for each trade or business. A Section 162 trade or business must be performed with continuity and regularity, and the taxpayer must primarily have a profit or income motive.
Whether or not a trade or business is considered an SSTB for QBI deduction purposes can have a significant impact on a high-income pass-through entity owner’s tax liability. Tax practitioners and taxpayers should carefully consider whether different divisions of a pass-through entity should be treated as separate trades or businesses and whether the de minimis SSTB rule applies.
If you aren't 100% confident your business and personal finances are structured to maximize the amount of the Sect 199A 20% QBI Deduction, let's take care that. Potentially powerful Sec. 199A QBI 20% Deduction strategies may assist you significantly increase the amount of the deduction you can quality for in 2023.
With the Sec 199A QBI Deduction scheduled to expire at the ending 2025, it's essential to capture the maximum deduction you can qualify for and deserve while you can.
Reach out to get our conversation started. You will be glad you did.
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