The QBI deduction is a complicated one that could help you save money on your business taxes.
- Qualified business income refers to the ordinary, non-investment income your cannabis company generates
- There a number of complexities that need to be taken into account when determining both the eligibility and the amount of the QBI deduction.
Speak to one of our experts to learn all the nuances of the 199A deduction.
For cannabis business operators starting their tax return, figuring out what deductions you can claim under the 280e can be a challenge. Many of the typical expenses small businesses write off are ineligible to cannabis companies. As a result, you may need to dig a little deeper to find tax deductions your cannabis company can claim.
One such deduction is the qualified business income (QBI). In addition to lowering the corporate tax rate to 21%, the 2018 tax law also created a 20% deduction for QBI available to the owners of partnerships, S corporations, and sole proprietorships.
Here’s what you need to know about how the new law works, and how you might be able to take advantage of the QBI deduction.
What is the QBI?
Qualified business income refers to the ordinary, non-investment income your cannabis company generates. It could be your revenue from sales, minus interest or dividend income or any other gains from sale of property. It also excludes earned income like salaries and guaranteed payment.
The calculation and determination of the QBI deduction can be an extremely complex endeavor, and our experts can help you figure out all the nuances of the deduction.
One item to note is that this new deduction is effective for tax years beginning after December 31, 2017 and ending before January 1, 2026.
Further, it seems unlikely that the deduction will be available for operators in the cannabis business, but it seems there may be potential for other businesses within an organization structure to qualify (e.g., management company and real estate holding company).
As a result, the following example will focus on ancillary cannabis activities for which the deduction may be potentially available.
Example: How to Apply the QBI Deduction to Cannabis Businesses
A single-filer taxpayer (ABC) has taxable income (before taking into account the QBI deduction) of $150,000 for the taxable year. ABC operates a cannabis business through multiple pass-through entities that are comprised of the following activities:
- Retail sales
- Management, and
- Real estate holding company
Again, the calculations for QBI can be intricate and we highly suggest working with a licensed tax professional to help you through the process so you can limit your tax liability.
For this example, we will assume that the retail sales activity does not qualify for the deduction due to Section 280E, and consequently, it’s activity will be excluded from the illustration. In addition, we are going to assume that the management and real estate activities rise to the level of a trade or business.
An important threshold question when determining the QBI deduction is whether the activity generating the income is a Section 162 trade or business. It’s important to note that this answer may not always be easily determinable, especially when analyzing real estate activities.
The activities generate the following during the taxable year:
When a single-filing taxpayer earns less than $157,500 ($315,000 for taxpayers married filing jointly), the calculation of the deduction is simple. ABC would take their QBI of $136,000 and multiply it by 20% to arrive at a deduction amount of $27,200.
However, if ABC’s taxable income were $210,000, then additional steps need to be taken in order to determine what ABC’s QBI deduction would be. Most simply, the new tax law provides that once ABC’s taxable income is above $207,500, a limitation applies to the amount of deduction they may claim. This limitation is equal to the greater of 1) 50% of W-2 wages or 2) 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.
For the goal of simplicity, this writing does not examine what happens when a taxpayer’s taxable income is in between $157,500 and $207,500. In practice, there are additional steps that need to be completed to determine the amount of deduction available. Essentially, limitations are phased-in within these amounts, and additional consideration must be given to whether the business generating the income is a “specified services trade or business”.
This is further complicated by the potential ability to aggregate certain types of businesses. In our example, assume that the management and real estate activities are eligible to be aggregated and ABC elects to do so. Under this approach, ABC’s deduction would be limited to the greater of 1) $17,500 (i.e., 50% of W-2 wages) and 2) $15,000 (25% x $35,000 = $8,750 + 2.5% x $250,000 = $6,250). Comparing $17,500 to the non-limited deduction amount of $27,200, ABC ultimately ends up with $9,700 in less deduction.
Alternatively, if ABC elects not to (or the activities are ineligible) aggregate, the answer changes. Under a non-aggregation approach, ABC’s deduction would be limited to $17,500 (down from $20,000 = 20% x $100,000) with respect to the management business and would be limited to $6,250 (down from $7,200 = 20% x $36,000). However, since these businesses are not aggregated, ABC is eligible to take a total deduction of $23,750 vs. $17,500 that was available when the activities were aggregated.
This simple example provides an illustration of the importance for companies to analyze their activities in order to determine the most beneficial structure available to maximizing the QBI deduction.
Should you take the QBI Deduction?
There are a number of other considerations and complexities that need to be taken into account when determining both the eligibility and the amount of the QBI deduction. This section of the new tax law is riddled with areas that need interpretation and traps for the unwary are ever prevalent. It is strongly advised that companies consult with their CPAs before taking the QBI deduction.