The Tax Cuts and Jobs Act which was enacted on December 22, 2017, created a new provision
called Qualified Business Income (QBI) under Sec. 199A.
Sec. 199A(a): Effective for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, a
taxpayer other than a corporation is entitled to a deduction equal to 20% of the taxpayer’s QBI
earned in a “qualified trade or business” (QTB).
The deductible amount of QBI for each of the taxpayer’s QTBs is determined separately and
added together. The sum of these amounts is then subject to a second limitation equal to the
excess of:
● The taxable income for the year, over
● The sum of net capital gain plus the aggregate amount of the qualified cooperative
dividends for the tax year.
Example: In 2022, John, a married taxpayer, has taxable income of $170,000, as follows:
● $100,000 of QBI,
● $100,000 of long-term capital gain, and
● $30,000 of deductions
John’s QBI deduction is limited to the lesser of:
● $20,000 (20% of $100,000) or
● $14,000 (20% of $70,000, the excess of taxable income of $170,000 over net capital
gain of $100,000).
Thus, John is entitled to a $14,000 QBI deduction in 2022.
Sec. 199A(c): QBI is the net amount of qualified items of income, gain, deduction, and loss with
respect to a qualified trade or business that are effectively connected with the conduct of a
business in the United States. However, some types of income, including certain investment-
related income, reasonable compensation paid to the taxpayer for services to the trade or
business, and guaranteed payments, are excluded from QBI.
Sec. 199A(d): QTBs include all trades and businesses except the trade or business of
performing services as an employee and “specified service” trades or businesses (SSTBs):
those involving the performance of services in law, accounting, financial services, and several
other enumerated fields, or where the business’ principal asset is the reputation or skill of one or
more owners or employees.
Sec. 199A(b)(2): The QBI deduction is limited, however, to the greater of:
● 50% of the W-2 wages with respect to the QTB or
● The sum of 25% of the W-2 wages with respect to the QTB, plus 2.5% of the unadjusted
basis immediately after acquisition of all qualified property.
Example: Paul owns a commercial rental property through a limited liability company (LLC). His
share of the rental income earned by the LLC is $800,000. The LLC pays no W-2 wages, but
Paul’s share of the unadjusted basis of the building is $10 million. Paul’s QBI deduction will be
the lesser of:
● 20% of QBI = $160,000 (20% of $800,000), or
● the greater of:
○ 50% of W-2 wages = $0; or
○ 25% of W-2 wages plus 2.5% of $10 million = $250,000
Thus, Paul is entitled to a $160,000 QBI deduction in 2022.
Sec. 199A(b)(3)(A) and (e)(2)(A): The W-2 and qualified property-based limitations do not apply
when the taxpayer claiming the deduction has taxable income for the year of less than $340,100
(if married filing jointly; $170,050 for all other taxpayers) (for 2022 tax year).
Sec. 199A(b)(3)(B): The W-2 limitations are phased in over the next $100,000 of taxable income
(if married filing jointly; $50,000 for all other taxpayers). Thus, once taxable income reaches
$440,100 for a married taxpayer filing jointly ($220,050 for all other taxpayers), the W-2
limitations apply in full.
Example: Smith is a sole proprietor. During 2022, the business generates $400,000 of QBI,
pays $120,000 of W-2 wages, and has $100,000 of qualified property. Smith files jointly with his
spouse for 2022, and their combined taxable income for the year, including the QBI, is
$600,000.
Smith’s tentative deduction is $80,000 ($400,000 × 20%). Because his taxable income for 2022
is greater than $440,100, the W-2 limitations apply in full. As a result, Smith’s deduction is
limited to the greater of:
● 50% of W-2 wages = $60,000; or
● 25% of W-2 wages ($30,000) plus 2.5% of unadjusted basis of qualified property
($2,500) = $32,500.
Thus, Smith is entitled to a $60,000 QBI deduction in 2022.
Passive activity losses (PALs) and QBI deduction: Per Treas. Regs. Sec. 1.199A-3(b)(1)(iv),
PALs are not taken into account for the QBI deduction if they are disallowed. In addition, any
losses disallowed before Jan. 1, 2018, are never taken into account for the QBI deduction.
Sec. 1231 effect on QBI deduction: Per Treas. Regs. Sec. 1.199A-3(b)(2), if a taxpayer has a
Sec. 1231 net loss at the individual level, it is treated as ordinary loss and included in QBI. Sec.
1231 gain is treated as capital gain and is excluded from QBI. But, if a taxpayer has a Sec. 1231
loss in a year and then has a Sec. 1231 gain sometime in the next five years, that gain is
treated as ordinary, not capital. Based on the preamble of the final regulations, any Sec. 1231
ordinary loss that reduced QBI in a prior year should be included in QBI in the recapture year.
Aggregation rules: Per Treas. Regs. Sec. 1.199A-4(a), aggregation allows a taxpayer or
relevant passthrough entity (RPE) to add together the QBI, W-2 wages, and unadjusted basis
immediately after acquisition of qualified property from all the businesses in an aggregated
group. The requirements to aggregate state that the same person or group of persons, directly
or by attribution rules, must own 50% or more of each TOB for the majority of the year, including
the last day of the year. Note that none of the TOBs can be SSTBs.
Rental Real Estate (RRE) businesses can qualify for QBI deduction: Rev. Proc. 2019-38 issued
on Sep 24, 2019, provided a safe-harbor procedure for taxpayers under which a RRE enterprise
is treated as a trade or business (TOB) for QBI deduction. Under the safe harbor, a “rental real
estate enterprise” is treated as a TOB for QBI purposes if at least 250 hours of services are
performed each tax year for the enterprise. For RRE enterprises that have been in existence for
at least four years, the 250-hour requirement will be met if, in any three of the five consecutive
tax years that end with the tax year, 250 or more hours of rental services are performed per
year for the RRE enterprise.
Tax Forms and Schedules for QBI Computation:
● Form 8995, QBI Deduction Simplified Computation;
● Form 8995-A, QBI Deduction;
● Schedule A (Form 8995-A), Specified Service Trades or Businesses;
● Schedule B (Form 8995-A), Aggregation of Business Operations;
● Schedule C (Form 8995-A), Loss Netting and Carryforward; and
● Schedule D (Form 8995-A), Special Rules for Patrons of Agricultural or Horticultural
Cooperatives.
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