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Qualified Business Income Deduction

The Tax Cuts and Jobs Act adds a new deduction for non-corporate taxpayers for qualified business income (also referred to as the "pass-through deduction"). The deduction is generally 20% of a taxpayer's qualified business income from a partnership, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to the trade or business. Certain types of investment-related items are excluded from qualified business income, e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). Employee compensation and guaranteed payments to a partner are also excluded. Taxpayers whose taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return) are also subject to limitations based on W-2 wages paid by the business and the business ' unadjusted basis in acquired qualified property.

Observation The term "pass-through deduction" itself is something of a misnomer as the deduction is available not only to pass-through entities such as partnerships, S corporations, and limited liability companies (LLCs), but also to sole proprietorships.

Observation While some businesses might be tempted to change their form in order to take advantage of the new pass-through deduction, there are many other factors that need to be considered-perhaps most notably, the newly reduced 21% income tax rate for C corporations. Commentators seem largely split on the relative benefits of pass-through vs. corporate form, and the best choice for any given taxpayer will likely depend on its particular facts and circumstances. Commentators also note that, while perhaps appealing on its face, converting from an employee to an independent contractor to obtain the benefits of the deduction, even if possible, requires some hard choices, such as giving up fringe benefits.

The deduction is taken "below-the-line," i.e., it reduces taxable income, rather than being taken "above-the-line," i.e., in determining adjusted gross income (AGI). However, the deduction can be taken by taxpayers who don't itemize their deductions.

The deduction applies only for income tax purposes; it thus doesn't apply, for example, for purposes of determining self-employment tax. For purposes of determining alternative minimum taxable income, qualified business income is determined without regard to any adjustments under Code Sec. 56 through Code Sec. 59.