The pass-through deduction is available to owners of sole proprietor-ships, single member limited liability companies (LLCs), partnerships, and S corporations. The deduction may also be taken by trusts and estates. The deduction is intended to reduce the tax rate on qualified business income to a rate that’s closer to the corporate tax rate.
The deduction is taken “below the line” and is available regardless of whether you itemize deductions or take the standard deduction.
The pass-through deduction has two components:
- 20% of QBI from a domestic business operated as a sole proprietor-ship or through a partnership, S corporation, trust or estate; and
- 20% of the taxpayer’s combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
A taxpayer’s QBI for a tax year is the net amount of the taxpayer’s qualified items of income, gain, deduction, and loss relating to any qualified trade or business.
QBI won’t necessarily equal the net profit or loss from a taxpayer’s business there could be other adjustments to get to QBI.
A qualified trade or business is any trade or business other than a specified service trade or business (SSTB, see below). But an SSTB is treated as a qualified trade or business for tax-payers whose taxable income is under a threshold amount.
SSTBs include health, law, accounting, actuarial science, performing arts (but not services by persons other than performing artists, such as promoters or broadcasters), consulting, athletics, financial services, broker-age services, investing and investment management, trading, dealing securities, and any trade or business where the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners.
Threshold amount. Threshold amounts apply for purposes of applying the SSTB rules (see above) and W-2 wage limit (see below). The threshold amounts are adjusted yearly for inflation. For tax years beginning in 2022, the inflation-adjusted threshold amounts are $170,050 for single and head of household returns, $340,100 for married filing joint re-turns, and $170,050 for married filing separate returns. The limits phase in over a $50,000 range ($100,000 for a joint return).
W-2 wage limit. Unless the taxpayer is below the threshold amount, the deductible amount is limited to the greater of:
- 50% of the W-2 wages relating to the qualified trade or business; or
- the sum of 25% of the W-2 wages relating to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all “qualified property.”Qualified property is depreciable property held by, and available for use in, the qualified trade or business at the close of the tax year; that’s used at any point during the tax year in the production of qualified business income.
Taxable income limit. The QBI component of the pass-through deduction is limited to 20% of the excess of the taxpayer’s taxable income over the taxpayer’s net capital gain.
Partnerships and S corporations. For businesses conducted through a partnership or S corporation, the pass-through deduction is calculated at the partner or shareholder level.