Small business owners need to consider taking advantage of all tax savings they are entitled to. One of the deductions available to small business owners is the Qualified Business income deduction or QBI deduction, which allows them to deduct up to 20% of their qualified business income and reduce their tax liability accordingly.
The QBI deduction can be claimed by filling out Form 8995 (A one-page simple calculation) or Form 8995-A (a four-page detailed calculation). Several online services assist with these forms, including the IRS. This post provides more information about the 8995, how to fill it out, which business and income types qualify, and the maximum limits on how much you can claim.
What is form 8995?
Business owners can reduce their tax bill by taking advantage of form 8995 and the QBI program (Qualified Business income deduction). It is also known as Section 199A deduction or pass-through deduction. Sole proprietors, partnerships, LLCs, or S Corporations can usually take advantage of this deduction.
There are limits to who can use form 8995 based on the type of income and the amount of income. However, it can provide up to a 20% reduction to your taxable income and reduce your business tax by thousands of dollars.
For example, a pass-through business earning $150,000 in specified business income can claim the QBI deduction and reduce taxable income by 20% to $120,000. Depending on the business’s tax rate, this can reduce the total tax bill by thousands of dollars in this example.
Most businesses that qualify can use form 8995, a simple one-page document to file the QBI deduction. Form 8995A is a detailed four-page document that a small number of qualified businesses must use.
Who can use Form 8995?
Form 8995 cannot be used by all businesses. An individual must own one of the following businesses that are considered pass-through businesses:
- LLC – Limited Liability Company
- Sole proprietorship
- Partnership
- S Corporation
- Horticulture or agriculture cooperative
- Trusts and estates
In addition, the type of income must fit into the following categories to be accepted in Form 8995.
- Rental Real Estate Income
- Qualified Public Traded Partnership income
- Qualified Real Estate Investment Trust income
- Pass through business income
Income Thresholds
The IRS has set various thresholds for the qualification of income for using the QBI deduction. The thresholds are adjusted each year by the IRS, and if your QBI exceeds the threshold for a given year, the IRS has additional criteria to help determine if you qualify for a partial deduction.
In 2021 the income threshold for married couples was $329,800 and $164,900 for individuals. These values are increased for 2022 to $340,000 and $170,050 respectively. You may qualify for the full deduction if you meet the structure criteria mentioned above and fall below the income levels required for the taxation year.
Conversely, if your income is above $429,800 for married couples or $214,900 for individuals, the deduction benefit phases out, and your company will pay the full taxes required by the IRS. In 2022, the limits increase to $440,100 and $220,050 respectively.
Most people will use the short form 8995 one-page document. However, if your income exceeds the thresholds set for the taxation year, it may be worthwhile to complete the detailed four-page form 8995-A. You must meet the criteria; however, by completing the detailed calculations, you may uncover additional deductions that will reduce your total tax liability for the year.
Incomes that are excluded from the pass-through deduction
The IRS guidelines indicate that the following types of income do not qualify for the QBI deduction and should be excluded from your deduction calculations. Examples of these income sources include:
- Dividends
- Capital gains and losses
- Wage or salary income
- Annuities unrelated to your business
- Income generated by non-US businesses
- Foreign market gains and losses
- Notional principal contract income, loss, or deductions
Claiming the pass-through deduction
If you use an accountant to prepare your tax filing statements for the IRS, they will be very familiar with when and how to use both forms 8995 and 8995-A. Preparing your tax files has become increasingly easier with the plethora of online tax services available to consumers and business entities. Always input the data carefully, check for typos and follow the guides and suggestions provided by these services to ensure accuracy and maximize your tax savings.
Report your business income and expenses on Schedule C, followed by your adjusted gross income on Form 1040. Familiarize yourself with the pass-through deduction, the criteria used to qualify your business, and the type of income. You may want to review the IRS support documentation for QBI on their website.
Filling Out Form 8995 and Completing QBI Calculations
This is a one-page form and relatively easy to complete. List the name of your business and taxpayer identification number in line one. You can include up to five businesses on line one.
The total qualified business income is entered on line 2. Include all income from all businesses you listed in line 1.
Business income varies from year to year. If there was a net business loss in the previous year, include this amount in line 3.
Combine lines 2 and 3 on line 4 to determine the sum of your income/loss from the current year with the business carry-forward loss of the previous year.
Multiply the value from line 4 by 20% to determine your QBI deduction for the current year.
In lines 6-10, include your current year’s income from real estate trusts and publicly traded partnerships. Add their incomes to the previous year’s losses for this type of income and calculate 20% of the total.
Income thresholds are calculated to assess if you qualify for the QBI deduction on lines 11-15. For 2021, if your total taxable income is less than the limits provided by the IRS, you can claim the pass-through deduction of 20%. Your QBI deduction is the lesser of 20% of your:
- Business income or;
- Taxable income less any net capital gains
Enter taxable business income and net capital gains from lines 3a and 7 on your form 1040 on lines 11 and 12. Next, subtract the net capital gains from your qualified business income and enter the result in line 13. Then, multiply the entry in line 13 by .2 to get 20%, and write the answer in line 14. The last step involves comparing the results in lines 10 and 14 and entering the lowest number in line 15. This is the QBI deduction you are entitled to.
If your net qualified business income is negative, you can carry it over to next year’s tax return and potentially use this loss to offset any potentially profitable business income you have in future years. Lines 16-17 are used to calculate these numbers.
Keep in mind when filling out Form 8995
Side gigs structured as a sole proprietorship, partnership, or LLC can qualify for the QBI deduction. Working as an UBER driver or pizza delivery driver can qualify if the income is structured appropriately. You cannot use your QBI deduction to offset salaried income from your employer.
The IRS updates its instructions and forms regularly to clarify questions and to help clients avoid making erroneous claims and deductions. Always review any updates provided by the IRS each year concerning Form 8995 and other tax documents.
While form 8995 is relatively straightforward, some clients may have questions and difficulties. Don’t hesitate to reach out for help to the IRS, online resources, or your accountant.
FAQs – Concerning QBI Form 8995 Deductions
An individual must own one of the following businesses that are considered pass-through businesses:
ᐅ LLC – Limited Liability Company
ᐅ Sole proprietorship
ᐅ Partnership
ᐅ S Corporation
ᐅ Horticulture or agriculture cooperative
ᐅ Trusts and estates
The following types of income generally qualify to be included in QBI calculations and deductions:
ᐅ Rental Real Estate Income
ᐅ Qualified Public Traded Partnership income
ᐅ Qualified Real Estate Investment Trust income
ᐅ Pass through business income
ᐅ The following types of income should be excluded from your deduction calculations.
Examples of these income sources include:
ᐅ Dividends
ᐅ Capital gains and losses
ᐅ Wage or salary income
ᐅ Annuities unrelated to your business
ᐅ Income generated by non-US businesses
ᐅ Foreign market gains and losses
ᐅ Notional principal contract income, loss, or deductions
In 2022, the limits will increase to $440,100 for married couples and $220,050 for single individuals. The IRS revises these limits each year and provides clarification regarding the type of business and income that can be considered for making a QBI deduction.
Yes, the limits may change every year. For example, the deduction limits for 2021 were $429,800 for married couples or $214,900 for individuals. In 2022, the limits increase to $440,100 and $220,050, respectively, and will likely change again in 2023.
Yes, the IRS does make changes to the restrictions from time and also adds clarifications to the instructions and definitions to help clients avoid making erroneous claims and deductions which must be repaid.
Key Points
The QBID or Qualified Business Income Tax deduction can reduce a small business’s tax significantly. Form 8995 is a relatively straightforward one-page document to fill out with detailed instructions provided by most online tax services and also from the IRS. Form 8995A is more detailed, with four pages of detailed information. Most businesses can use the one-page document.
The QBID has several restrictions in terms of types of businesses and types of income. You cannot use the deduction to reduce your salaried income or wage-based income.
Businesses can reduce their taxable income by up to 20%, provided they meet specific income limitations concerning amounts and types of income. QBI losses can also be carried forward to future years and used to offset future profitable taxable income. If in doubt, seek assistance from the online resources of the IRS.
