The 2017 Tax Cuts and Jobs Act created a new federal tax deduction for individual taxpayers of up to 20% of “qualified business income” realized by a partnership, S corporation or a sole proprietorship. While a number of limitations apply, this deduction has the potential to reduce the effective tax rate on such income by up to 7%. The ability of a taxpayer to benefit from the deduction is based upon a number of factors including the taxpayer’s taxable income, the nature of the business activity, the amount of employee wages paid by the business and other factors. Understanding these essential details can facilitate proper planning to take advantage of the deduction.

Qualified business income is business income from a qualified trade or business that excludes investment items such as interest, dividends and long term capital gains and losses. Qualified income is derived only from domestic business activities and does not include reasonable compensation paid to an S corporation owner or guaranteed payments paid by a partnership to a member.

Qualified business income generally does not include income from a specified service business. A specified service business means a trade or business performing services in a variety of professional fields including health, law, accounting, investment management, consulting and others, but excluding architecture and engineering. A specified services business also includes any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners. With such a broad definition, there is bit of a “gray area” as to which taxpayers will have income from a specified service business. The determination is fact-specific, and taxpayers along with their advisors should analyze their businesses to determine if all or a portion would qualify for favorable treatment under these provisions.

The limitation on specified service income described above does not apply to taxpayers with taxable income below certain thresholds (single taxpayers with taxable income less than $157,500 and married taxpayers with taxable income less than $315,000 in 2018). The limitation on specified service income is then phased-in over the next $50,000 of taxable income above these thresholds. This should provide relief for many taxpayers around the country, but should only add to the complexity for those living in the dense metro areas where average incomes are highest.

A wage limit applies in determining the tentative deductible amount of qualified business income for taxpayers with taxable income exceeding the thresholds described above. In determining the tentative deduction with regard to any qualified trade or business, a taxpayer’s deduction (generally calculated as 20% of qualified business income) is limited to the greater of: (a) 50% of the W-2 wages from the qualified trade or business, or (b) the sum of (i) 25% of W-2 wages from the qualified trade or business and (ii) 2.5% of the unadjusted basis of all depreciable property used in the qualified trade or business. For businesses such as rental real estate that may not incur significant wage expense, the ability to deduct 2.5% of the cost basis of the depreciable property utilized in the business is a significant benefit. The deduction determined after applying the W-2 wage limit is tentative because the final deduction cannot exceed 20% of taxable income excluding any net capital gain. Thus, a taxpayer’s deduction measured after applying the W-2 wage limit to its qualified business income could be further limited due to insufficient taxable income if the taxpayer had losses from nonqualified trades or businesses.

The deduction for qualified business income presents an opportunity for taxpayers to pay a substantially reduced effective rate of federal tax on the receipt of certain types of business income; but the provisions governing the deduction are quite complicated and involve a number of factors. Here at FF&F our experienced staff can assist you in determining the extent you may benefit from this deduction. For more information on this topic or our services, please contact us at or (212) 245-5900.


Hunter Norton, J.D.L., LL.M., CPA, is an accomplished Tax Director with FF&F. Prior to joining the firm, he spent 7 years as an attorney at Withers Bergman LLP, a tax-oriented law firm, and 8 years in the Tax practice with Deloitte. His areas of expertise include business and investment partnerships, cross-border tax matters, high net worth individuals, and family offices. Hunter’s experience also allows him to advise clients in income tax matters related to trusts, estates and grantors, and taxable gifts, as well as estate planning.