The Qualified Business Income Deduction is a relatively new tax deduction that offers considerable benefits to self-employed people and other small business owners. It provides a deduction for up to 20% of the income you earn from your business, so it can help S Corp owners save on their taxes.
What is the Qualified Business Income Deduction?
The Qualified Business Income (QBI) deduction was implemented in 2018 and offers a deduction of up to 20% for certain types of business income. It primarily applies to self-employed people and small business owners, which means people who run S Corps can benefit from it.
If you’re eligible for the QBI deduction, you can deduct up to 20% of your business income from your taxable income. For example, if you have $100,000 in qualified business income, you can deduct $20,000, leaving you with $80,000 in taxable income.
This deduction will end after 2025, meaning it will apply to the tax return you file for the 2025 tax year. If it’s not extended, business owners can no longer take the deduction starting with the 2026 tax year.
What Counts as Qualified Business Income?
The good news for business owners is that the definition of qualified business income is rather broad. According to the IRS, QBI is “the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business.”
Specific exclusions are:
- Items not properly includable in taxable income
- Capital gains and losses
- Interest income that isn’t allocable to a trade or business
- Wage income
- Income that isn’t effectively connected with the conduct of business within the U.S.
- Commodities or forex gains and losses
- Certain dividends
- Annuities
- Reasonable compensation from an S Corp
- Guaranteed payments from partnerships
- Qualified REIT dividends
For most people who run a company located in the United States, this means that your QBI will be equal to your business’s net profits.
Note that reasonable compensation, which for S Corp owners is the salary they pay themselves, is excluded from QBI. If your business makes $120,000 and you pay yourself a salary of $60,000, you only get the QBI deduction of the remaining $60,000.
Other Requirements for the QBI Deduction
There are a few additional requirements that you must meet if you want to take the QBI deduction.
First, you have to stay under a taxable income limit based on your filing status. In 2023, the income limit for single people and those married but filing separately is $182,100. For joint filers, the limit is $364,200.
If you exceed the income limit, things get more complicated. Whether you remain eligible depends on the nature of your business.
If you work in a specified services trade or business (known as SSTBs), then the deduction begins to phase out once you hit the income limit. It goes away entirely at an income of $232,100 for single filers and $464,200 for joint filers.
SSTBs are those in the following fields:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Investing and investment management
- Trading
According to the IRS, any business in which the “principal asset of a trade or business is the reputation or skill of its employees or owners if the trade or business consists of the receipt of income from endorsing products or services, the use of an individual’s image, likeness, voice or other symbols associated with the individual’s identity, or appearance at events or on radio, television, and other media outlets,” also counts as an SSTB.
In other words, if you’re making money like a celebrity through product endorsements, appearance fees or use of your image, you’re not eligible.
Finally, you can only deduct a maximum of 20% of your taxable income, even if your QBI is more than that. The good news is that you don’t need to itemize deductions to take the QBI deduction. You can take it on top of the standard deduction, which is $13,850 per person in 2023.
Why It Matters to S Corp Owners
The QBI deduction is a massive benefit for S Corp owners and is one of the things that makes S Corps an excellent way to save money.
In addition to saving money on payroll taxes by taking a portion of your company’s income as distributions rather than wages, you get to deduct roughly 20% of those distributions from your taxable income, saving you even more.
Consider this simple example. You have a business that brings in $140,000 each year, and your only expense is your own wage, which is $90,000. You take the remaining $50,000 as a distribution.
That $50,000 distribution isn’t subject to payroll taxes, which total 15.3%. This saves you $7,650 off the bat. Then, you get to deduct 20% of that amount from your personal income when filing your tax return, which means you get $10,000 of that $50,000 effectively tax-free.
Based on that income, you’d likely be in the 24% tax bracket, which applies to single filers with taxable incomes between $95,375 and $182,100 for 2023. This means that the QBI deduction saves you an additional $2,400.
The more your business earns and you take in distributions, the more the QBI deduction helps you save.
Final Word
The QBI deduction is a boon for S Corp owners and other self-employed individuals, letting them deduct up to 20% of their profits from their income taxes. Most S Corps in the U.S. are eligible to take the deduction, so take advantage to minimize your tax liability.
TJ Porter is a freelance writer based in Boston, Massachusetts. He began covering finance while earning a degree in business at Northeastern University in Boston, Massachusetts and enjoys writing about credit, investing, real estate topics. When he’s not writing, TJ enjoys cooking, sports, and games of the video and board varieties. You can contact him at find more of his work at TJPorterWriting.com