QBI Deduction: Limitations Based on W-2 Wages and the basis of qualified propertyDecember 13, 2018
The Tax Cuts and Jobs Act (TCJA) introduced many changes to the qualified business income (QBI) deduction, including a W-2 wage limitation. Read on to see if you might be impacted.
The new deduction for qualified business income (QBI) under the Tax Cuts and Jobs Act (TCJA) is subject to many rules and restrictions, including limitations based on W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property. Here are the details of those specific limitations.
Limiting the Deduction
Your QBI deduction may be as much as 20% of your QBI from a pass-through entity, such as a sole proprietorship, partnership, limited liability company (LLC) or Subchapter S corporation. However, the deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and any net capital gains.
The deduction starts to phase out if when taxable income (calculated before any QBI deduction) exceeds $157,500, or $315,000 for married people who file jointly.
The W-2 wage and the UBIA of qualified property limitations are fully phased in once taxable income exceeds $207,500 for unmarried people, or $415,000 for married people who file jointly. After it’s fully phased in, the QBI deduction is limited to the greater of:
- Your share of 50% of the W-2 wages with respect to the qualified trade or business, or
- The sum of your share of 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the UBIA of qualified property.
The latter limitation benefits capital-intensive businesses with substantial investments in fixed assets, such as manufacturers and contractors. There are additional limitations in place for service businesses.
Crunching the Numbers
The IRS recently issued guidance to clarify how to calculate W-2 wages and UBIA of qualified property. It defines the term “W-2 wages” as the total amount of compensation paid to an employee subject to wage withholding, including salary-reduction contributions to retirement plans (elective deferrals) and deferred compensation. W-2 wages don’t include any amounts that aren’t properly reported to recipients and the Social Security Administration on Forms W-2.
The guidance provides several methods for calculating W-2 wages for purposes of the QBI deduction limitation. Most companies will use the unmodified box method, which takes the sum of entries on either Box 1 or Box 5 of all Forms W-2 filed with the Social Security Administration (SSA).
Some companies may need to use more complicated methods to calculate W-2 wages. For example, if you have a short tax year (with less than 12 months), you’re required to use the tracking wages method. This technique includes only wages paid to employees during the short tax year plus employee salary-reduction contributions to retirement plans made during the short tax year.
When computing the UBIA of qualified property, the guidance takes into account any depreciable fixed assets (including real estate) that the pass-through entity owns which is used in the production of QBI. The UBIA is essentially the original cost of the asset without any reduction for subsequent deprecation.
W-2 wages paid by a pass-through entity and the UBIA of qualified property must be separately determined for each qualified trade or business the business conducts and separately reported to owners. An owner’s allocable share of W-2 wages for QBI deduction purposes is determined in the same manner as the owner’s allocable share of those wages under the normal federal income tax rules. You can elect to aggregate (combine) one or more businesses, along with the W-2 wages paid by those businesses and the UBIA of qualified property.
The rules for claiming the QBI deduction are long and complex — and many restrictions apply. Our tax professionals can help you sort through the details of this tax break, including the limitations based on W-2 wages and the UBIA of qualified property.
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