The Tax Cuts and Jobs Act of 2017 brought tax relief for American taxpayers and corporations, and it also provided a new tax saving opportunity for independent business owners in the form of the targeted deduction for Qualified Business Income (QBI) of a pass-through entity.

If you qualify for this valuable tax savings tool, we walk you through the mechanics of how to make sure you are taking full advantage of it in this article.

The Qualified Business Income deduction allows most self-employed taxpayers and small business owners to exclude up to 20% of your qualified business income from federal income tax whether you itemize or not on your tax return.

The deduction amount depends on your total taxable income, which includes wages, interest, capital gains (etc.) in addition to income generated by the business itself. The QBI provides tax relief on your taxable income in 2022 up to $170,050 for individual filers (and up to $340,100 for married couples filing joint returns). The type of business you own also comes into play.

At incomes at or below these levels, the deduction is 20% of either taxable income (minus capital gains and dividends) or the QBI, whichever is less. At higher income levels however, the deduction is reduced or eliminated, depending on the nature of your business.

What does and does not qualify as “qualified business income”?

First, what it’s not. QBI is defined as net business income, excluding the following:

  • Any income generated outside the United States
  • Any of your investment income
  • W-2 compensation paid to you if you are an S corporation owner
  • Guaranteed payments to a partner
  • Income from REITs, publicly traded partnerships, and qualified cooperatives

What types of businesses do qualify for the QBI deduction?

It applies to anyone who is a sole proprietorship and other self-employed business owners (Schedule C filers), as well as LLCs, partnerships, S corporations, estates, and trusts. Corporations (C corps) are not eligible for the deduction.

Also keep in mind, not every eligible business automatically qualifies for the QBI deduction. In particular, some types of businesses (Specified Service Trade or Businesses, or SSTBs) are disqualified once the taxable income for 2022 on your tax return exceeds $270,050 (or $440,100 if filing jointly).

The IRS defines an SSTB as a trade or business involving the performance of services in the fields of: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business principal asset is the reputation or skill of one or more of its employees or owners.

For business owners who invest in real estate the good news is that certain rental enterprises may qualify for the QBI deduction. First, the bad news. Income earned from the following types of rental property is specifically excluded from taking advantage of the QBI deductions:

  • Passive rental activities that are not considered a trade or business

For example, a single-family home rented out for a year or more in which there is little or no interaction between the landlord and the tenants other than periodically collecting rent and the occasional repair.

  • Property used as your own primary residence for any part of the year. This includes vacation homes, cabins, or seasonal residences.
  • Triple-Net leases, where the tenant or lessee pays real estate taxes, insurance, and maintenance in addition to rent and utilities.
  • Rentals located outside the United States, and
  • Land rentals

If your rental income comes from any of the above categories, unfortunately you don’t qualify for the QBI deduction for the income you generate.

If you are considered a real estate professional for tax purposes, however (over 50% of the personal services you performed during the tax year was in a real estate business you participated in for more than 750 hours that same year) then your rental income does qualify for the QBI deduction.

But what if you own rental property, but don’t qualify as a real estate professional? The good news is you may still qualify for the QBI deduction as long as your rental activities are considered a trade or business. Here’s how.

Each of your rental properties or group of similar properties including K-1 rental income, must satisfy the following requirements:

  • Each rental enterprise must maintain its own books and records to track income and expenses.
  • At least 250 hours of rental services must be performed each year per rental enterprise; and
  • Records of services performed must be kept which includes who performed the service, description of service, the date of the service, and how long it took (who, what, when, and how long).

Keep in mind, even if your rental property fails to satisfy the above requirements, your real estate enterprise may still be treated as a qualified trade or business for the purposes of the QBI deduction, provided it meets the definition of a trade or business under IRS rules.

Is my business an SSTB?

The specified service trade or business (SSTB) designation reduces or eliminates the 20% Qualified Business Income (QBI) deduction at higher income levels. But the official definition of an SSTB can be vague and open to interpretation, so the IRS has provided additional guidance on determining if you are an SSTB.

Remember, the SSTB label does not matter if your total taxable income in 2022 (non-business as well as business income) is less than $170,050 (or $340,100 if you’re filing jointly).

At these lower income levels, owners of SSTB as well as non-SSTB businesses can qualify for the same QBI deduction: 20% of either taxable income (minus cap gains and dividends) or qualified business income, whichever is less. The SSTB distinction matters only for higher income earners.

Businesses that are not SSTBs

Many single-owner and self-employed businesses are definitely not SSTBs, which means they can still qualify for at least a partial QBI deduction if the taxpayer’s total income exceed in 2022 $270,050 or $440,100 if filing jointly. But at these higher income levels, SSTBs no longer qualify for the deduction.

Common non-SSTBs include:

  • Engineering
  • Real estate and property management (more info)
  • Contracting
  • Restaurants
  • Architecture

Bottom line: The Tax Cuts and Jobs Act of 2017 delivered a new tax deduction available to small business owners in the form of the Qualified Business Income (QBI) deduction, and you should be sure you are taking full advantage of it. To find out more about the QBI deduction and find out if you qualify, simply reach out to one of our experienced pros at TSP Family Office. We have worked with thousands of clients over the past 18 years to help them save money on their taxes, and we are happy to walk you through the process and answer any questions you may have about the QBI Deduction, or any other tax issue. Give us a call today at (772)257-7888 to learn more.