The 2017 Tax Cuts and Jobs Act introduced Section 199A, offering a qualified business income (QBI) deduction for eligible self-employed individuals, small business owners, and other pass-through entities. Understanding what constitutes a "qualified trade or business" (QTB) under Section 199A is crucial for claiming this valuable deduction. This guide will delve into the intricacies of this definition, clarifying the requirements and addressing common questions.
What is a Qualified Trade or Business (QTB)?
A qualified trade or business, for the purposes of Section 199A, is essentially any trade or business other than specifically excluded activities. This includes a wide range of activities, from sole proprietorships and partnerships to S corporations and LLCs taxed as pass-through entities. The key is that the business must be actively engaged in a trade or business that generates profit. Simply investing in assets and collecting passive income doesn't qualify.
Key Characteristics of a QTB:
- Active Participation: You must actively participate in the business's management and operations. This generally means regular involvement in making business decisions.
- Profit Motive: The primary purpose of the business must be to generate a profit. Hobby activities, even if they generate some income, typically don't qualify.
- Legal Business Entity: The business must be a legally recognized entity, such as a sole proprietorship, partnership, LLC, or S corporation.
What Businesses are NOT Considered Qualified Trade or Businesses under Section 199A?
Several types of activities are specifically excluded from the QBI deduction under Section 199A. These generally include:
- Capital Gains and Losses: Income from the sale of capital assets, such as stocks or real estate held for investment, is not considered QBI.
- Interest Income: Interest income from loans or investments is typically excluded.
- Dividends: Dividend income from stock investments is not part of QBI.
- Wage Income from Employment: If you're an employee, your wages aren't considered QBI, even if you own the business.
- Certain Specified Service Trades or Businesses (SSTBs): These include businesses such as law, accounting, medicine, performing arts, and financial services. While SSTBs can qualify, there are limitations based on taxable income. We will explore this further below.
What are Specified Service Trades or Businesses (SSTBs)?
As mentioned, Specified Service Trades or Businesses (SSTBs) are subject to special rules under Section 199A. While they can qualify for the QBI deduction, the deduction is capped if your taxable income exceeds certain thresholds. This means your deduction may be limited, depending on your income level.
Examples of SSTBs:
- Law: Attorneys, legal professionals.
- Accounting: CPAs, accountants, tax preparers.
- Medicine: Physicians, surgeons, dentists.
- Performing Arts: Musicians, actors, dancers.
- Financial Services: Investment advisors, financial planners, brokers.
What if My Business is a Combination of QTB and Non-QTB Activities?
Many businesses engage in both qualifying and non-qualifying activities. In such cases, you must allocate the income and expenses between the QTB and non-QTB portions to determine your QBI deduction. This can be a complex process, and professional advice is often recommended.
How Much is the QBI Deduction?
The QBI deduction is generally the smaller of 20% of your QBI or 20% of your taxable income (without considering the QBI deduction itself). However, for SSTBs, the deduction is limited depending on your taxable income. Specific income thresholds are adjusted annually for inflation, so it's crucial to refer to the latest IRS guidelines.
Can I Claim the QBI Deduction if I'm an Employee and Owner?
This depends on the structure of your business. If you are an S-corp shareholder and receive a salary as an employee, then you would not be able to deduct the wage income as QBI. However, the business income allocated as "distributions" from the S-corp may be eligible for the deduction. It's highly recommended to seek advice from a tax professional in this situation.
This guide provides a general overview of Section 199A and the concept of a qualified trade or business. The rules are complex, and specific situations may require professional guidance. Always consult with a qualified tax advisor or CPA to determine your eligibility for the QBI deduction and to ensure you are complying with all relevant tax laws.
