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What is Included in Qualified Business Income (QBI)?
Qualified Business Income (QBI) plays a significant role in determining the deduction available to certain pass-through business owners under the Tax Cuts and Jobs Act (TCJA) of 2017. Understanding what constitutes QBI is essential for taxpayers seeking to optimize their tax planning strategies. So, what exactly is included in QBI income? Let’s explore.
Definition of Qualified Business Income (QBI)
Qualified Business Income refers to the net income, gain, deduction, and loss generated from qualified trades or businesses operated within the United States. These businesses are typically structured as sole proprietorships, partnerships, S corporations, or certain trusts and estates. QBI does not include income earned from specified investment-related items, such as capital gains, dividends, interest income, or certain other passive sources.
Components of QBI Income
Net Income from Business Operations: The primary component of QBI income is the net income derived from the ordinary course of business operations. This includes revenues generated from selling goods or services, minus allowable business expenses such as wages, rent, utilities, supplies, and other costs incurred in generating business income.
Capital Gains and Losses: While capital gains and losses are generally excluded from QBI, certain gains and losses attributable to the sale of business assets may be included. For example, gains or losses from the sale of depreciable property used in the business may be considered QBI if they meet specific criteria outlined in the tax code.
Interest and Dividend Income: Income earned from interest, dividends, royalties, and other investment-related sources is typically excluded from QBI. However, if these income sources are directly related to the operations of a qualified trade or business, they may be considered QBI. For example, interest income earned by a lending business or royalties earned by a publishing company may qualify as QBI.
Rental Income from Real Estate: Rental income derived from real estate activities may be included in QBI if the taxpayer qualifies as a real estate trade or business under the IRS guidelines. To qualify, the taxpayer must be actively involved in managing the rental properties, and the rental activities must rise to the level of a trade or business as defined by the tax code.
Guaranteed Payments to Partners: Guaranteed payments made to partners in a partnership are typically treated as ordinary income and included in QBI. These payments represent compensation for services rendered or the use of capital and are subject to self-employment tax.
Exclusions from QBI Income
While QBI encompasses various income sources related to qualified trades or businesses, certain types of income are explicitly excluded from QBI. These exclusions include:
- Wages earned as an employee: Wages and salary income earned as an employee are not considered QBI.
- Investment income: Income from capital gains, dividends, interest, royalties, and other passive sources is generally excluded from QBI.
- Certain specified service activities: Income from specified service trades or businesses (SSTBs) may be subject to limitations or exclusions from QBI, depending on the taxpayer’s taxable income and other factors.
In summary, Qualified Business Income (QBI) encompasses various income sources generated from qualified trades or businesses, including net income from business operations, certain capital gains, rental income from real estate activities, and guaranteed payments to partners. Understanding the components of QBI income is essential for taxpayers seeking to maximize their QBI deduction and optimize their tax planning strategies. Consulting with a tax professional can provide further guidance on navigating the complexities of QBI and maximizing tax benefits.
Stay informed, stay compliant.
