What does the QBI deduction expiration mean for you?

If you're a small-business owner or independent contractor, tax benefits likely play a big part in your financial planning. One significant tax break, the qualified business income (QBI) deduction, allows eligible business owners to deduct up to 20% of their qualified business income, reducing their taxable income and, ultimately, their tax bill.

However, this valuable tax deduction isn't permanent. The expiration of the QBI deduction, scheduled by the end of 2025, could mean a higher tax liability for many business owners.

Let's go over what you need to know about the QBI deduction, its scheduled expiration and steps you can take to prepare.

The QBI deduction was a significant component of the Tax Cuts and Jobs Act (TCJA) of 2017, designed to provide tax relief to owners of pass-through businesses, including sole proprietorships, partnerships, limited liability companies and S corporations.

The primary goal of the QBI deduction was to level the playing field between corporations (which benefited from a substantial corporate tax rate reduction under the TCJA) and smaller businesses that typically operate as pass-through entities. It allowed eligible business owners to deduct up to 20% of their qualified business income from their individual income tax returns.

The QBI deduction has a built-in sunset provision, meaning it's scheduled to stop at the end of 2025 unless it's extended by legislation before then. As that deadline approaches, it's unknown if Congress will continue the QBI deduction or allow it to expire. Regardless, business owners who have relied on the deduction to lower their taxable income should consider how the QBI deduction going away would impact their future financial strategies.

The QBI deduction allows individuals to deduct up to 20% of their net income from pass-through businesses on their tax return, but it's limited by a couple of factors.

The QBI deduction applies to income from pass-through entities. Qualified business income generally includes net income from the business, excluding capital gains or losses, dividends, interest and certain foreign income.

The QBI deduction has income limitations to ensure it benefits small businesses. Those income limitations determine whether you can claim the full deduction, a partial deduction or none at all.

The specifications for income limits depend on whether the business is a specified service trade or business (SSTB). These are service-based businesses (other than engineering or architecture) that rely on the owner's or employees' reputation or skill. Examples of SSTBs include business in fields like health, law, accounting, financial services, consulting and performing arts.

For 2024, the income limitations for owners of SSTBs are as follows:

• Single filers. Business owners with taxable income below $191,950 can claim the full deduction. Those with taxable income over $241,950 can't claim the deduction. Income that falls between those thresholds qualifies for a partial deduction.
• Married filing jointly. Business owners with taxable income below $383,900 can claim the full deduction. Those with taxable income over $483,900 can't claim the deduction. Income that falls between those thresholds qualifies for a partial deduction.

Non-SSTBs can claim the full QBI deduction if their taxable income is less than $241,950 for single filers or $483,900 for married couples filing jointly. However, for those with taxable income over those limits, the QBI deduction is limited to the greater of:

• 50% of the business' W-2 wages
• 25% of the business' W-2 wages plus 2.5% of qualified property

Calculating the QBI deduction is complex, so most business owners rely on a tax professional or tax software to handle the calculations. However, understanding how it works can be helpful as you develop any financial plans that are affected by the deduction.

Many business owners and individual tax filers who benefit from the QBI deduction could see a significant increase in their tax liabilities if the deduction phases out as planned in 2025.

Independent contractors and owners of small businesses that operate as pass-through entities use the QBI deduction to offset their taxable income and could face a higher effective tax rate. This could be especially impactful for new businesses and entrepreneurs planning to leverage the QBI deduction to ease their tax burden during their startup and growth phases, as losing the deduction makes it more challenging to reinvest profits into the business.

It won't affect specified service trades or businesses—even those structured as partnerships, LLCs or S corporations—with taxable income above the cut-off, as they couldn't claim the QBI deduction anyway.

Other affected groups should begin planning for the future by adjusting financial planning strategies to accommodate the higher tax burden.

With the QBI deduction scheduled to sunset at the end of 2025, business owners and independent contractors who've relied on this benefit should begin preparing for a potentially higher tax bill.

Here are some practical steps to consider.

The first step to prepare for the possible expiration is to review your current tax strategy with a tax professional. Understanding how the loss of the QBI deduction personally will affect your taxable income allows you to make necessary adjustments now. Consider accelerating income into 2024 and 2025 or deferring expenses to 2026 to maximize the deduction while it's still available.

While the QBI deduction may be ending, other deductions and credits can help reduce your taxable income. Work with your tax advisor to consider whether some of the following deductions can benefit you:

• Section 179 deduction. This allows businesses to deduct the full purchase price of qualifying equipment and software placed in service during the tax year.
  
• Bonus depreciation. Available through 2026, businesses can deduct a significant percentage of the cost of qualifying business assets in the year they're placed in service.
  
• Home office deduction. If you operate your business from home, you may be able to write off a portion of your home expenses related to business use.

Increasing contributions to retirement accounts can serve dual purposes: reducing taxable income and boosting retirement savings. Contributions to tax-advantaged accounts like traditional IRAs, SEP IRAs, 401(k)s or SIMPLE IRAs can help offset some of the tax increases you may face after the QBI deduction is gone.

Preparing for a higher tax bill means revisiting your business's budget and cash flow projections. Factor in the increased tax liability to maintain adequate cash reserves to cover the additional expense. You may need to cut costs in other areas, raise prices or find new revenue streams to offset the loss of the deduction.

As the sunset of the QBI deduction approaches, remember that this situation is still fluid. Congress could extend the deduction or introduce new tax benefits to make up for its loss. However, given the uncertainty of future tax legislation, preparing for any potential outcome is a good idea.

Talk to a Thrivent financial advisor, who can provide you with personalized guidance. Having a solid plan helps you manage your tax liability and continue to grow your business confidently, regardless of the tax landscape that lies ahead.