Of the many modifications in effect for the 2018 tax year, perhaps the most exciting change is the new Pass-through Tax Deduction. The deduction has many other names: Its official title is the Qualified Business Income (QBI) deduction, it is also known as the Section 199A deduction and the small business tax deduction. Whatever title you prefer, the bottom line is: it creates a reduction in taxable income of up to 20% for the lucky individuals with the right types of income.
This is where things get tricky. How do you know if you have the right type of income? Here’s a quick cheat sheet. If you are an employee (you receive Form W-2 each year), you do not have the right type of income. If your money earns you interest income, you do not get the new deduction for this. If you made money on sales of securities or real estate it will not be eligible. Social Security income and Pension income are also not eligible. Almost any other type of income may be eligible for the new deduction.
If you are still reading, it is safe to assume that you or someone you care about has potentially eligible income (or you really love tax articles). Most of you will have one of the following income types: Self-employment Income, Retail Income (store or ecommerce) or Rental Income (basement rentals may not qualify). These income types will almost always qualify for the new tax deduction. Generally speaking, it does not matter if the income is reported directly on your individual tax return (Schedules C or E), or separately on a partnership or other business tax return. In the latter case the income will be received on an annual Schedule K-1 (the form that reports your annual share of Partnership or S-Corp Income).
So how does the deduction actually work? First, you need to figure out how much of the relevant income you have. If you have Self-employment income, this will be the net income (income after all expenses) of your business. The income is further reduced by any other deductions you might have on your personal tax return. This includes deductions for health insurance, retirement plan contributions, the standard deduction or your itemized deductions (mortgage interest, taxes, charity etc.). Once you have arrived at the taxable eligible income you will receive a deduction equal to 20% of the remaining income. More calculations and rules come into play when you have multiple income types (some eligible and some not), and for incomes exceeding 315,000 (MFJ or 157,500 Single).