Pass through entities include, LLCs, partnerships, S Corporations and sole proprietorships. It means that profits and losses from the business pass through directly to the shareholder’s individual tax returns. Under the Tax Cuts and Jobs Act, for tax years beginning after December 31, 2017 through December 31, 2025, some individuals will be able to deduct 20% of their Qualified Business Income (QBI).

What is QBI? QBI is the net amount of income, gain, deduction and loss with respect to the trade or business. QBI does not include investment income or interest income. Note that only certain pass through entities qualify for this new QBI incentive. Generally, the deduction is subject to a limit based either on wages paid or wages paid plus a capital element. The formula for determining the limitation is as follows; the limitation is the greater of: (i) 50% of the wages paid with respect to the qualified trade or business; or (ii) the sum of 25% of the W-2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis (determined immediately after an acquisition) of all qualified property. The 50% of wages limitation does not apply to taxpayers who file married filing jointly with an income of $315,000 or less, and for all other individuals with an income of $157,000 or less. A phase – out comes into play over the next $100,000 of taxable income for couples filing married filing jointly, and $50,000 for other individuals, subject to inflation adjustments. There are QBI exclusions, such as reasonable compensation paid to the taxpayer for their services. This includes reasonable compensation paid to individuals by S-Corporations (W2 wages). W2 wages generally equals the sum of wages, subject to tax withholding, elective deferrals, and deferred compensation paid to the taxpayer by the S-Corporation, or other pass-through entities during the tax year. Certain service businesses are excluded from QBI as well. The fields that these businesses fall under are as follows;

• Accounting; Health; Law; Engineering; Architecture; Financial Services and Any business where the principal asset of the business is the reputation or skill of one or more of its employees.

As you can see from the list, the fields excluded from QBI are all potentially high earning fields of work. The 20% deduction is not allowed in computing Adjusted Gross Income(AGI). The deduction is allowed as a deduction reducing taxable income. Therefore, the deduction does not affect limitations based on AGI. Keep in mind that unless legislation is enacted to extend the 20% deduction, it is due to sunset December 31, 2025