The Qualified Business Income Deduction (QBID)
One of the largest deductions for business owners is the Qualified Business Income Deduction (QBID). Many high-earning business owners do not get the max benefit from this deduction and do not even realize it.
If your taxable income is under $182,100 (single) or $364,200 (married filing jointly), the QBID is pretty straight forward – you receive a 20% deduction from your business income (Sole proprietorships, Partnerships, and S-Corps).
If your income is over those amounts – certain limitations apply.
One limitation, which we will focus on in this post, revolves around W-2 Wages.
Simply put, the amount of your QBID cannot exceed 50% of the W-2 wages you pay.
- If your business pays 200k in W-2 wages, the amount of the QBI Deduction cannot exceed 50% of that (100k).
When it comes to S-Corporation owners, they have the opportunity to pay themselves a salary (which could help them avoid the W-2 wages limitation of the QBID.
Let’s look at an example.
A business owner owns 100% of an S-Corporation. His business had paid $300k in wages to employees (not including himself), and $160k in wages to himself ($460k wages total). The business had a net income (after all salaries paid) of $1.5 million.
This means that, because the business paid $460k in wages, the maximum QBID the owner would qualify for is $230k (50% of wages).
Ideally, the owner would want to get the maximum benefit of the QBID, which is 20% of the business income. The owner can do so simply by paying himself a larger salary.
If the owner paid himself $100k more in wages (and he was not married), the first 40k would be subject to 2.9% in medicare taxes, and the next 60k would be subject to an additional 0.9% ACA tax (3.8% total). He would have already paid in the maximum amount to Social Security ($160,200 in 2023), so Social Security Tax is not a factor.
This means that the additional $100k in wages are subject to around $3,440 in payroll taxes. Half of these are deductible ($1,720).
By paying himself the additional $100k in wages, the business’s net income decreased from $1,500,000 to $1,400,000.
The maximum QBID he can receive on $1,400,000 of business income (20%) is $280,000.
Because he paid himself an additional $100k in wages (now a total of $560,000 in wages paid by the business), the wages limitation is not a factor (50% of $560,000 = $280,000)
So as you can see the QBID ($280k) = the wages limitation ($280k) and the Qualified business income deduction is optimized.
This is how it plays out for tax purposes:
- Originally, on $1,500,000 net income (but limited by 50% of the $460k wages paid) the business owner only qualified for a QBI deduction of $230,000. At the marginal tax rate of 37%, this has a dollar value of $85,100.
- By paying himself the additional $100k of wages, the business now had a net income of 1,400,000 (no wages limitation). The 20% QBI deduction on that would be $280k. At the marginal tax rate of 37%, this has a dollar value of $103,600.
- The business owner paid an additional $3,440 in payroll taxes, but half of which are deductible ($1,720). At the 37% marginal tax rate, the deduction has a dollar value of $636.
In the end, by paying himself 100k more in wages, the business owner:
- Received an additional 50k deduction (worth $18,500)
- Paid an additional $3,440 in payroll taxes
- And received a $1,720 payroll tax deduction (Worth $636).
$18,500 – $3,440 + $636 = $15,696.
The business owner saved an additional $15.6k in taxes, and this required essentially no effort whatsoever (simply running one more payroll to himself at the end of the year in order to make up the difference).
When businesses do not have many W-2 employees, maximizing the QBI deduction could save even more in taxes. This affects lean business with not many employees (such as a Saas business, Info-Product sellers, and Content creators) as well as subcontractor type businesses (contractor labor does not count as W-2 wages for the QBID).
