8584 / How is the Section 199A QBI deduction calculated for taxpayers with income that exceeds the relevant threshold levels?

(1)  The QBI component (see below), and

(2)  20 percent of the combined amount of qualified REIT dividends and qualified PTP income.

This amount is then compared to 20 percent of the amount by which the taxpayer’s taxable income exceeds net capital gain. The lesser of the two amounts is the Section 199A deduction.¹ For a relatively simple business with no qualifying REIT dividends or PTP income, the calculation is fairly straightforward, as illustrated in Example 1.

Example 1: Kevin owns land that is leased as beach parking in a tourist town. His business generated $1 million QBI for the year, and paid no wages. His UBIA for the year was zero, because the land he owns is not depreciable and, as such, is not qualified property. After unrelated deductions, his taxable income was $980,000. He exceeds the threshold limits, so must complete the calculations regarding the W-2 wage and QBI limits. However, because both of these figures are zero, his QBI deduction is zero.

Before calculating the “QBI component,” the taxpayer must take the following computational steps to determine the figures that will apply in calculating the QBI component itself:

(1)  SSTB Exclusion. The SSTB exclusion (see Q ) is applied first. If the SSTB’s income is within the phase-in range (see below), then the relevant percentage of QBI, W-2 wages and UBIA is taken into account. If the SSTB’s income is above the phase-in range, none of the taxpayer’s QBI, W-2 wages or UBIA are taken into account in calculating the deduction.

(2)  Aggregation. If the taxpayer aggregates businesses, the QBI, W-2 wages and UBIA of all businesses must first be aggregated before applying the W-2 and UBIA limits below.

(3)  Netting. If QBI from any one business is negative, the taxpayer must offset QBI from other businesses that had positive QBI for the year with the QBI from each business with negative QBI. This is done in proportion to the relative amounts of net QBI in the businesses with positive QBI. This “adjusted QBI” is used in figuring the deduction, as indicated below.

See Q for a discussion of the “phase out range.”

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Planning Point: Any W-2 wages or UBIA of qualified property are not considered or carried over to subsequent years if the business’ QBI was negative.

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(4)  Carryover. If QBI from all businesses is negative, the QBI component is zero. The negative amount is treated as negative QBI from a separate trade or business in the next year. ²

At this point, the “QBI component” is the lesser of:

(a)  20 percent of QBI (as adjusted above) with respect to the trade or business, or

(b)  the greater of (x) 50 percent of W-2 wage income or (y) the sum of 25 percent of the W-2 wages of the business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (UBIA).³

Example 2: Frank (single) owns a 50 percent interest in Z-Mart, an S corporation that conducts a single trade or business. In 2023, Z-Mart had QBI of $6 million. Z-Mart paid total W-2 wages of $2 million, and its total UBIA of qualified property is $200,000. For 2023, Frank had $3 million of QBI from Z-Mart. Frank is not an employee of Z-Mart and receives no wages or reasonable compensation. After allowable deductions unrelated to Z-Mart and a deductible qualified net loss from a PTP of ($10,000), Frank’s taxable income is $1,880,000.

Because Frank’s taxable income is above the threshold amount, the QBI component of Frank’s Section 199A deduction will be limited to the lesser of (i) 20 percent of his share of Z-Mart’s QBI or (ii) the greater of the W-2 wage and UBIA of qualified property limitations. 20 percent of Frank’s share of QBI of $3 million is $600,000. The W-2 wage limitation equals 50 percent of Frank’s share of Z-Mart’s W-2 wages ($1 million) or $500,000.

The UBIA of qualified property limitation equals $252,500, the sum of (i) 25 percent of Frank’s share of Z-Mart’s W-2 wages ($1 million) or $250,000 plus (ii) 2.5 percent of Frank’s share of UBIA of qualified property ($100,000) or $2,500. The greater of the limitation amounts ($500,000 and $252,500) is $500,000. The QBI component of Frank’s Section 199A deduction is thus limited to $500,000, the lesser of (i) 20 percent of QBI ($600,000) and (ii) the greater of the limitations amounts ($500,000). Frank had a qualified loss from a PTP and has no qualified REIT dividend. Frank does not net the ($10,000) loss against QBI. Instead, the portion of Frank’s Section 199A deduction related to qualified REIT dividends and qualified PTP income is zero for 2023.

Frank’s Section 199A deduction is equal to the lesser of (i) 20 percent of the QBI from the business as limited ($500,000) or (ii) 20 percent of Frank’s taxable income over net capital gain ($1,880,000 x 20% = $376,000). Therefore, Frank’s section 199A deduction is $376,000 for 2023. Frank must also carry forward the ($10,000) qualified loss from a PTP to be netted against his qualified REIT dividends and qualified PTP income in the next taxable year.

See Q for a discussion of the results if the business’ income is within the phase-out range.