8585 / How is the Section 199A QBI deduction calculated for taxpayers with income that is within the “phase in” or “phase out” range between the relevant threshold levels?

Here, the “QBI component” discussed in Q is 20 percent of QBI for the trade or business reduced by a “reduction amount.” The “reduction amount” is the excess amount multiplied by the ratio that (1) the taxable income of the individual for the taxable year in excess of the threshold amount, bears to (2) $50,000 (or $100,000 for joint returns). The “excess amount” is 20 percent of QBI over the greater of (a) 50 percent of W-2 wages or (b) the sum of 25 percent of W-2 wages plus 2.5 percent of the UBIA of qualified property.² This calculation is complex, as illustrated by the example below, which was taken from the regulations themselves.

Example 1: Ben and Cary are married and file a joint return. Ben is a shareholder in M, an S corporation that conducts a single trade or business. M holds no qualified property. Ben’s share of M’s QBI is $300,000 in 2022. Ben’s share of the W-2 wages from M in 2022 is $40,000. Cary earns wages from employment by an unrelated company. After allowable deductions, Ben and Cary’s taxable income for 2022 is $375,000. Ben and Cary are within the phase-in range. Consequently, the QBI component of Ben and Cary’s Section 199A deduction may be limited by the W-2 wage and UBIA of qualified property limits, but the limits will be phased in. Ben and Cary must take the following steps:

The UBIA of qualified property limitation amount is zero because M does not hold qualified property.

Ben and Cary must apply the limitations by first determining 20 percent of Ben’s share of M’s QBI. 20 percent of Ben’s share of M’s QBI of $300,000 is $60,000.

Next, Ben and Cary determine 50 percent of Ben’s share of M’s W-2 wages. 50 percent of Ben’s share of M’s W-2 wages of $40,000 is $20,000.

Because 50 percent of Ben’s share of M’s W-2 wages ($20,000) is less than 20 percent of Ben’s share of M’s QBI ($60,000), Ben and Cary must determine the QBI component of their 199A deduction by reducing 20 percent of Ben’s share of M’s QBI by the reduction amount. Ben and Cary are 60 percent through the phase-in range (i.e., their taxable income exceeds the threshold of $315,000 by $60,000 and their phase-in range is $100,000).

Ben and Cary must determine the excess amount, which is the excess of 20 percent of Ben’s share of M’s QBI, or $60,000, over 50 percent of Ben’s share of M’s W-2 wages, or $20,000. Thus, the excess amount is $40,000.

The reduction amount is equal to 60 percent of the excess amount, or $24,000.

Thus, the QBI component of Ben and Cary’s 199A deduction is equal to $36,000 (20 percent of Ben’s $300,000 share M’s QBI (that is, $60,000), reduced by $24,000).

Ben and Cary’s Section 199A deduction is equal to the lesser of (i) 20 percent of the QBI from the business as limited ($36,000) or (ii) 20 percent of their taxable income ($375,000 × 20% = $75,000).

Therefore, the Section 199A deduction is $36,000 for 2022.

A second example using the same facts shows application of the relevant rules when the business is a specified service trade or business (SSTB, see Q ).

Example 2: Assume the same facts as in the example above, except assume now that M is an SSTB. Because Ben and Cary are within the phase-in range, Ben must reduce the QBI and W-2 wages allocable to Ben from M to the applicable percentage of those items.

Ben and Cary’s applicable percentage is 100 percent reduced by the percentage equal to the ratio that their taxable income for the taxable year ($375,000) exceeds their threshold amount ($315,000), or $60,000, bears to $100,000. Their applicable percentage is 40 percent.

The applicable percentage of Ben’s QBI is ($300,000 x 40% =) $120,000, and the applicable percentage of Ben’s share of W-2 wages is ($40,000 × 40% =) $16,000. These reduced numbers must then be used to determine how the 199A deduction is limited.

Ben and Cary must apply the W-2 wage limitation by first determining 20 percent of Ben’s share of M’s QBI as limited above. 20 percent of Ben’s share of M’s QBI of $120,000 is $24,000.

Next, Ben and Cary must determine 50 percent of Ben’s share of M’s W-2 wages. 50 percent of Ben’s share of M’s W-2 wages of $16,000 is $8,000. Because 50 percent of Ben’s share of M’s W-2 wages ($8,000) is less than 20 percent of Ben’s share of M’s QBI ($24,000), Ben and Cary must determine the QBI component of their Section 199A deduction by reducing 20 percent of Ben’s share of M’s QBI by the reduction amount.

Ben and Cary are 60 percent through the phase-in range (meaning their taxable income exceeds the threshold amount by $60,000 and their phase-in range is $100,000). Ben and Cary must determine the excess amount, which is the excess of 20 percent of Ben’s share of M’s QBI, as adjusted above, or $24,000, over 50 percent of Ben’s share of M’s W-2 wages, as adjusted above, or $8,000. Thus, the excess amount is $16,000.

The reduction amount is equal to 60 percent of the excess amount or $9,600.

Thus, the QBI component of Ben and Cary’s Section 199A deduction is equal to $14,400, 20 percent of Ben’s share M’s QBI of $24,000, reduced by $9,600.

Ben and Cary’s 199A deduction is equal to the lesser of (i) 20 percent of the QBI from the business as limited ($14,400) or 20 percent of Ben’s and Cary’s taxable income ($375,000 × 20% = $75,000). Therefore, Ben and Cary’s section 199A deduction is $14,400 for 2022.³

This calculation essentially means that an SSTB business with income within the phase-in range must apply both the limitation on the amount of QBI that can be taken into account, and also the limit on W-2 wages/UBIA of qualified property.