Two short weeks ago, we dissected perhaps the most widely-anticipated but least-understood aspect of the Tax Cuts and Jobs Act: the new deduction available to business owners. As a reminder, under the new law, after January 1, 2018, the owner of a:
- sole proprietorship reported directly on Schedule C
- rental activity reported directly on Schedule E
- S corporation, or
…is entitled to take a deduction equal to 20% of the “qualified business income” earned from the business.
Qualified business income is best thought of as the ordinary, non-investment income of the business. Stated in another way, this is the revenue the business was designed to generate, less the applicable expenses. So we ignore things like interest or dividend income or capital gains from the sale of property.
The deduction, however, is limited to the LESSER OF:
- 20% of qualified business income, or
- 50% of the total W-2 wages paid by the business.
There is also an alternative limitation based on the owner’s allocable share of 2.5% of the unadjusted basis of certain business assets, but let’s cast that aside for today.
Authored by Tony Nitti, Withum Partner and writer for Forbes.com.