Pass-Through Entity Basics: Understanding QBI Deduction

Understanding Pass-Through Entities

A pass-through entity is a business structure where income is not taxed at the business level. Instead, the income, deductions, and credits pass through to the individual owners' personal tax returns. Common pass-through entities include sole proprietorships (Schedule C), partnerships (Form 1065, with K-1 to partners), and S-Corporations (Form 1120-S, with K-1 to shareholders).

The QBI Deduction: 20% Deduction on Business Income

The Qualified Business Income (QBI) deduction allows eligible taxpayers to deduct up to 20% of their qualified business income from pass-through entities. This deduction was created to provide pass-through business owners with a benefit comparable to the lower corporate tax rate.

QBI includes the net income from a qualified trade or business operated through a pass-through entity. It does not include capital gains or losses, interest income not properly allocable to the business, or employee compensation.

Negative QBI and Carryovers

When your total qualified business income is less than zero — meaning your pass-through businesses had net losses — you have negative QBI. In this situation, you cannot claim the 20% QBI deduction for that year. However, the negative QBI amount carries forward to future years.

In future years when you have positive QBI, the carried-forward negative amount will offset that positive QBI before the 20% deduction is calculated. This reduces the benefit of the QBI deduction in future years but does not eliminate it entirely.