Net business income earned from a U.S. pass-through entity that may be eligible for a 20% federal tax deduction under Section 199A of the U.S. Tax Code.
What is Qualified Business Income
Qualified Business Income (QBI) refers to the net income generated from the operations of a U.S. pass-through business, such as a sole proprietorship, partnership, S corporation, or certain LLCs. Under Section 199A of the Internal Revenue Code, individuals who earn QBI may be eligible to deduct up to 20% of that income from their taxable income on their U.S. federal tax return.
This deduction, introduced as part of the Tax Cuts and Jobs Act of 2017, was designed to offer tax relief to owners of small and mid-sized businesses. It applies only to domestic business income, and does not include capital gains, interest, dividends, or wage income.
To qualify, the income must come from a “qualified trade or business,” and the deduction is subject to various limitations based on:
- The taxpayer’s total taxable income
- The type of business activity
- Wages paid and capital investment in the business
- Whether the business is considered a “specified service trade or business” (SSTB), such as law, consulting, or financial services—which may face phaseouts at higher income levels
For non-U.S. residents, claiming the QBI deduction can be complex and depends on whether the U.S. income is considered effectively connected income (ECI) with a U.S. trade or business and whether the taxpayer is required to file a Form 1040-NR or Form 1120. Additionally, the deduction only applies to individuals (not corporations), so a foreign individual operating through a disregarded LLC or partnership may be eligible if the structure meets IRS criteria.
The QBI deduction is not automatic; it must be calculated and claimed on the appropriate IRS forms, often using Form 8995 or Form 8995-A, depending on the complexity of the business and income level.
In summary, QBI is a significant tax benefit for U.S. pass-through business owners, potentially reducing their effective tax rate. However, eligibility rules are detailed, and foreign owners of U.S. entities should consult with a qualified tax advisor to determine whether and how the QBI deduction applies to their specific situation.
