New 20% Deduction for Schedule C Filers
There’s a lot of confusion and buzz around the new 20% deduction for small business owners. Who does it apply to? How does it work? When do you take it? There are many variables and conditional statements within this new law. Before we get too deep into it, let’s start by understanding how this new deduction applies to the most common business entity: Schedule C - Sole Proprietor.
Of the 26 million business in the United States, over 10 million are sole proprietors filing Schedule C. The amount of deduction you receive depends on what type of business you have, your business profits, and your taxable income. Let’s look at some examples to understand how this works.
QBI Deduction Reduces Income Tax
The first thing to note is that this new deduction only applies to income tax, not self-employment tax. The deduction reduces taxable income, which in turn reduces the tax you owe. Here’s an example:
Without the 20% QBI Deduction |
With the 20% QBI Deduction |
|
Single |
Single |
|
$165,000 Taxable Income |
$165,000 Taxable Income |
|
2018 Tax Rate = 32% |
<$30,000> QBI Deduction |
|
Tax = 32% x $165,000 = $52,800 |
$135,000 NEW Taxable Income |
|
2018 Tax Rate = 24% |
|
|
Tax = 24% x $135,000 = $32,400 |
Calculate the QBI Deduction
How do you calculate the 20% QBI deduction? Let’s start with taxable income. If you file Single or Head of Household, your magic number is $157,000. If you’re married filing jointly, your magic number is $315,000.
Individuals |
Married Filing Joint |
|
Below $157,500 |
Below $315,000 |
If your taxable income is below these threshold amounts, your deduction is not limited by the type of business you run or by how many employees you have. Your QBI deduction will simply be the lowest of:
- 20% of your Schedule C Net Income or
- 20% of your Taxable Income
George’s Secret Side Business
To help illustrate this, let’s look into the life of George. George is a tax professional who works as an employee at Jimmy Tax Service. George earns $50,000 in employee wages which shows up on his W-2. During the year, George also had a secret side business preparing tax returns for friends and family. His secret side business netted him $100,000 in profits. He reports this on a Schedule C.
$50,000 in W-2 Employee Wages
$100,000 Schedule C Net Income
Total Income $150,000
Single Standard Deduction <$12,000>
SE Tax Deduction <$7,065>
Taxable Income $130,935
Now, to calculate the QBI deduction, take the lesser of
20% of the Schedule C Net Income
20% of $100,000 = $20,000
Or 20% of the Taxable Income
20% of $130,935 = $26,187
In this case, the lesser amount is $20,000.
How does this affect his tax return? His taxable income is reduced by $20,000.
His new taxable income is $130,935 - $20,000 = $110,935. With a lower taxable income, George now owes less tax.
George Does His Own Thing
The following year, George drops his job at Jimmy Tax Service and focuses 100% on his business. He ends up making the same, $100,000.
$100,000 Schedule C Net Income
Total Income $100,000
Single Standard Deduction <$12,000>
SE Tax Deduction <$7,065>
Taxable Income $80,935
Now, to calculate the QBI deduction, take the lesser of
20% of the Schedule C Net Income
20% of $100,000 = $20,000
Or 20% of the Taxable Income
20% of $80,935 = $16,187
In this case, the lesser amount is $16,187.
How does this affect his tax return? His taxable income is reduced by $16,187.
His new taxable income is $80,935 - $16,187 = $64,748. With a lower taxable income, George now owes less tax.
George Finds Love
The following year, George falls and love and marries Jenny. Jenny is a marketing executive at a big tech firm and makes $150,000 a year. George still makes $100,000.
$150,000 in W-2 Employee Wages from Jenny
$100,000 Schedule C Net Income from George
Total Income $250,000
Single Standard Deduction <$24,000>
SE Tax Deduction <$7,065>
Taxable Income $218,935
Now, to calculate the QBI deduction, take the lesser of
20% of the Schedule C Net Income
20% of $100,000 = $20,000
Or 20% of the Taxable Income
20% of $218,935 = $43,787
In this case, the lesser amount is $20,000.
How does this affect his tax return? His taxable income is reduced by $20,000.
His new taxable income is $218,935 - $20,000 = $198,935. With a lower taxable income, Jenny and George now owe less tax.
George Makes Too Much Money
The following year, George steps up his game and makes $300,000 in Net Income from his business. Jenny still makes $150,000.
$150,000 in W-2 Employee Wages from Jenny
$300,000 Schedule C Net Income from George
Total Income $450,000
Single Standard Deduction <$24,000>
SE Tax Deduction <$4,017>
Taxable Income $421,983
Since their taxable income is above $415,000 and George’s tax business is classified as a Specified Service Trade or Business, they don’t qualify for any QBI deduction.
QBI Deduction Can Be Very Complex
You may be asking what type of business are classified as Specified Service Trade or Business? What if George becomes an S-Corporation? What if George has rental income? Albeit these are very good questions, we must examine them at a later time. Before you confuse yourself with the many complexities of Section 199A, make sure you understand how to calculate the QBI deduction for a taxpayer with taxable income below the threshold amount. Good luck and stay tuned for more.
