By Thomas Larson, Self-Employment Manager at Prepare + Prosper
As part of tax law changes passed in 2017 (in effect for tax year 2018), there is a new tax deduction for self-employed workers called the Qualified Business Income (QBI) Deduction (also known as the pass-through deduction). Sole proprietors and other entrepreneurs filing Schedule C are eligible for this deduction.
Who Qualifies for the Deduction?
There are a couple of eligibility rules that apply to anyone who might qualify for the QBI deduction:
- You must have business income that you report on your personal tax return (Schedule C)
- Not all business income qualifies. The deduction does not include capital gains or losses, dividends, interest income, or income earned outside the U.S.
Your total taxable income (including all income, not just business income) also affects eligibility for the deduction. For tax year 2018, single filers at or below $157,500 and joint filers at or below $315,000 can take the deduction if the rules above apply. However, the rules are complicated for people making over those amounts. If you’re over the income limit, see the IRS rules for the deduction.
How is the deduction calculated?
The QBI deduction reduces the money you earn that is subject to income tax (NOT self-employment tax). There are two ways to calculate the deduction—the QBI is the lesser of the two numbers.
Here’s the first way: Take your business income (the net profit on Schedule C) and subtract contributions to a retirement account, the deduction for any self-employed health insurance payments, and half of self-employment tax. Then, multiply that number by 20 percent for your QBI deduction payments.
Here’s the second way: Take 20 percent of your overall adjusted gross income minus the standard (or itemized) deduction and capital gains.
This blog has an example for how to calculate the QBI deduction. The QBI does not affect any calculations on your Schedule C.
Bottom line – for most sole proprietors, independent contracts and others filing Schedule C who earn less than the income requirements, the new QBI deduction should help your bottom line!