In our most recent blog on this topic – Part 2 of a 4-part series – we explained how Congress denied or restricted the 20% Qualified Business Income (QBI) deduction to owners of Specified Trades or Businesses (SSTBs) that earned more than an indexed amount.

Today, in Part 3 of our 4-part series, we will get granular and demonstrate how the actual tax deduction is calculated. As a quick reminder, only “pass-through” businesses qualify (think Sole Proprietorship, Partnership, LLC (potentially), or S Corporation).

Here’s our fact pattern:

  • Penelope Planner owns American Financial Planning, LLC. The LLC elected to be taxed as a partnership and is therefore considered a “pass-through” business
  • The business is a financial services firm specializing in financial planning services for military servicemen and servicewomen.
  • Penelope is married and files as married filing jointly with her husband. In the examples below, remember that the 20% Business Income deduction is 20% of the LESSER of qualified business income or taxable income on Form 1040.
  • The LLC earned $200,000 in qualified business income (pre-tax profits) for the current year
  • Penelope and her husband have a current year taxable income of $210,000, which includes capital gains of $20,000.

Step 1:

Adjust the couple’s taxable income as required by the IRS:

Taxable income on the couple’s tax return BEFORE the 20% QBI deduction $210,000
Less capital gains – 20,000
Taxable income for the 20% QBI Deduction $190,000

Step 2:

Select the lower of the couple’s taxable income ($190,000) or the qualified business income of the LLC ($200,000).

Step 3:

The QBI deduction is 20% of $190,000 ($38,000).

Here’s your takeaway – The deduction is indeed 20%, but of what? The actual deduction is limited either by the taxpayers’ taxable income (as adjusted) or the Qualified Business Income of the business.

Stay tuned for our final blog in this series. Now that we have shown you how to calculate the basic deduction, we will up the ante by demonstrating a far more sophisticated version of this basic example.