 Hello and welcome to this session in which we will discuss the limitation on qualified business income deduction, section 199 of the IRS, or known as QBI deduction. In the prior session, we looked from an overall perspective and we learned that this deduction is worth the lesser of 20% of your qualified business income or 20% of your modified taxable income. That's the general rule. Now, Congress, again, this is simply a deduction that's given to you if you are a sole proprietorship, a partnership, or an S corporation, which is a pass through entity, not a C Corp. However, Congress is a generous to a point. Yes, they're going to give you the 20%, but they're going to limit you. And in this session, we'll talk about the limitation. Now, make sure in the prior session, you are comfortable with what's QBI, what's a qualified business, what's modified taxable income, what are the TI. And we briefly discussed the three limitations, which are an overall limitation based on modified taxable income. That's the first limitation. The second limitation applies to high income taxpayers. And this is what we would learn in this session focus on this limitation. And the third limitation apply to certain type of businesses, which we'll talk about in the next session. So in this session, we will focus specifically on high income taxpayers. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. So let's discuss the income limitation. First, we're going to work with a single individual. And as long as the single individual with a taxable income of less than 182,200, and here we are dealing with 2023 figures. You could be looking at this recording in 2024, 2025, and if this law is extended further. Well, the numbers will change, but the concept is the same. Up to 232,200. So we have a 50,000 range. Here's what happened. As long as your taxable income is below this amount, 182,200, before you get into the range, generally speaking, you'll get a full 20% deduction. Once your taxable income starts to go into 182,200 plus an additional 50,000, this is the range, you're going to be limited. Your deduction will be limited. And once your taxable income exceeds 232,200, it means from 182,200 to 232,200, you will start to lose some of the deduction. Once you exceed 232,200, here's what's going to happen. We're going to have to treat your business as an SSB business or a non-SSB business. Don't worry. I'm going to define this term in a moment. Just focus with me. If it is an SSB business, SSB business, you're done. You lose your deduction. So if you are above 232, an SSB business, you are gone. And to help you remember, I am an SSB business and I will explain it in a moment. If you're a non-SSB business, well, we're going to have to work some limitations. This is what we will do. Don't worry in this chapter. For merit filing jointly, they're a little bit more generous because you got two individuals at least, merit filing jointly, they might have dependent. The phase out will start at 364,200. Again, for the year 2023, there's a $100,000 range. And remember, this is called the range. We're going to come back and use this number. The range is 100,000 up to 464,200 above that amount. If you're an SSB, you're done. If you're a non-SSB, we have to do some computation. So less than this threshold, which is this amount here, less than this amount, no limit apply. Business will qualify. Nothing to think about it. Within the range, if you're within the range, if you are within this $50,000 or $100,000 range, we'll have to do a computation which we would learn in this chapter, in this session more specifically. More than this threshold, whether you are SSB, not SSN, social security number, SSB, which is specified service business or a non-SSB. If you are an SSB, you are done. You cannot get any deduction anymore. Your deduction is zero. You don't get the deduction. Why? Because you're an SSB business. What is that? Just give me a moment. I'm going to tell you what an SSB business is in a moment. So if you are an SSB business and you're above 464,200, that's it. The answer, look for the answer of zero. If not, we'll see what we need to do. What are SSB businesses? SSB businesses are doctors, dentists, lawyers, accountant, consultants, investment advisors, entertainers, athletes, and YouTubers. I told you my business is an SSB business. Now, what's special about this SSB business? What's common between all these businesses? What's common between all these businesses is the initiative, the reputation of the owner themselves. So for example, let me tell you an example about myself. As a YouTuber, I cannot hire someone to do YouTubes for me. I mean, I am the YouTube channel. Okay? So I'm an SSB business. I am the person. I am the business. My reputation, my effort, my skills, my personal initiative is the business. Therefore, if I don't exist, doesn't exist. Think about an athlete, same concept. Entertainer, actor, actress, same concept. Right? So this is what an SSB business is. What we are saying is this. Once an SSB business makes above a certain amount, they no longer qualify for this deduction. This is what we are saying. Simply put, this is what we are saying. Well, if you're an athlete, a YouTuber, entertainer, but you are not making a lot, they would allow this deduction for you. What's a lot and not a lot? The numbers will change every year. You have 2023 on the screen in front of you, plus those figures will change. If not SSB. So now we're talking about, if not SSB, well, limitation is based on wages other than yourself and capital investment. And this is what we'll discuss in this session. What happened if you are not an SSB, you are either within the range or outside the range. What do we have to do under those circumstances? Now, bear in mind, engineers and architect are not considered SSB. Just know it, the IRS decided that or Congress. So they're not SSB businesses. Just in case, you got a multiple choice question. You know, engineers and architect, you would think they are SSBs, but they are not SSBs. So let's talk about limitation based on wages and capital investment. Well, limitation based on wages and capital investment, it's going to be limit you. So this is the limitation that we're talking about once you exceed a certain number, once you exceed that number, that limit, once you exceed the threshold. The limits of the 20% QBI is the greater of. Now, don't worry, we're going to look at numbers, work with numbers. Greater of 50% of W2 wages, assuming you are labor intensive company, you have many employees, or 25% of the W2 wages paid plus 2.5% of qualifying property. Well, you will either take the greater of these two. So when you're computing A, which is 50% of wages or B, 25% of wages plus 2.5% of the the qualifying property, you will take the greater of these two. You're going to take the greater of these two and compare it to the 20% of QBI. But between A and B, you will take the greater of these two. Now, what do we mean by W2 wages? Simply put W2 wages, any wages subject to income tax withholding, compensation paid into a qualify retirement plan. That's also if even if it's not taxable, it's still W2 wages and certain other forms of the third compensation. Simply put, W2 is encompass everything. What do we mean by qualifying property? Qualifying or qualified property refer to depreciable, depreciable, depreciable, tangible. It means not intangible. So intangible are not considered here and it's depreciable, not land. So those two assets are not part of your qualifying property, either personal or real. Personal is other than building or warehouses, nothing attached to the land. Real is building warehouses, something attached to the land. This is what we mean by this. And they cannot be fully depreciated because they have to have an unadjusted basis. And remember, land and intangible asset are not considered qualified property. Now, the best way to work this is to start with a simple example, then build on that simple example. Adam, a married taxpayer who runs a business as a sole proprietary with a single employee earning $90,000 in 2023. Adam don't have any asset, so you don't have to worry about, so it's a labor intensive company. They reported $550,000 in qualified business income and their taxable income before QBI is $620,000 in 2023. Well, guess what? If we look at a married filing jointly and their qualified business income is $550,000, only from the qualified business income, let alone the taxable income, but their taxable income is $620,000, we come back here to the limitation. And what we find out is, wow, Adam is above the limitation, right? So, but we're going to assume Adam is a non-SSB, non-SSB. So if they're SSB, the problem is done. They don't qualify, right? But they're not SSB. The first limitation, remember, we cannot exceed more than 20% of modified taxable income. And for this purpose, we're going to assume taxable income and modified taxable income are the same. In the prior session, we learned how to compute modified taxable income. Well, we have to take out qualifying dividend and net capital gain. We don't have any of this. Therefore, we're going to take 620 times 20%. And right here, our deduction cannot exceed 124, because this is the first limitation that we talked about in the prior session. Now, let's talk about how we compute now the limitation because Adam is outside the range. As Adam surpasses 464,200, which is the range, his qualified business income deduction is limited to 20% of 550, so 20% of QBI, or the lesser of that, 50% of the W2 wages, which are 90,000 times 50%. Why don't we use the capital plus 2.5%, blah, blah, blah, all of this? We don't have any asset. It's supposed to be this plus 25% of W2 plus 2.5% of qualifying property. We don't have qualifying property. And when we are computing A and B, we use the greater. Therefore, we don't have to even do B. So it's those two figures, the lesser of these two figures, 45 or 110. Which one is the lower of these two? 45. We're not done. We're going to compare 45 to 124. Is 45 more than 24? No. So we don't have that limitation. Therefore, qualified business income deduction is 45,000. So this example shows you outside the range, and it's a non-SSB business. And we don't have, we don't have, we don't have what? We don't have assets. We only have W2s. Noah and me, and this is going to be a long example, married couple, finally return 2023, have a taxable income of 510, which also serve as their modified taxable income. Their modified taxable income is 510. At this point, if I multiply this by 20%, I know whatever answer I got. Let me get the answer now. Times 0.2, my deduction cannot exceed 102. Okay? Because it cannot exceed 20% of modified taxable income. They own two-member LLC operating as a partnership, and they have a restaurant that generated 420,000 in qualified business income. So Noah and me, Noah and Mia, they have this restaurant and generated 420,000. During the year, they employed two managers, and they paid them in total 155,000 in wages. They also have a building that they purchased four years ago for 600,000 with land worth 100,000. Now, don't worry for the sake of this illustration. The unadjusted basis is 520. You might be saying the basis of the furniture and properties is 500,000. We're going to assume they made more adjustments. They increased the basis. It doesn't matter their basis is 520,000. Now we need to compute, again, the limitation. And they are outside the range. Outside the range. What do we do when we are outside the range? Well, we're going to take 20% of QBI and compare it to the wages and capital investment. So let's do this. Starting with 20% of QBI, 420,000 times 20%. So this is the first computation. Now we're going to have an intermediate step. In this intermediate step, we compare A to B. A is 50% of W2 wages, which is 155 times 50%, 77,500. Then step two is 25% of W2 25% of W2 plus 2.5% times the qualifying property. 25% of 155 plus 2.5% of the unadjusted basis, which is the qualifying property. When we do this, if my math is right, we get 51,750. Now between A and B, we choose the greater between A and B. And the greater between A and B is 77,500. Now, to find out what is our QBI, we compare one, the lower of one or two. One is 84,000, which is 20% of QBI. Two is 77,500. We choose, obviously, two. We're not done yet. Remember, we have an overall limitation. And what's the overall limitation? 102. We are below the 102. Therefore, the answer is 77,500. So don't worry. I will work another example where we go above the overall limitation, but we'll keep this for another session. OK? So sometime your answer could be more greater than modified taxable income, 20% of modified taxable income. Therefore, you will take modified taxable income. Now what happened if we are within the range? Remember when I started this session, I told you we could be outside the range. We could be below the range, which is easy. We could be below the range, which is no issues whatsoever. We could be outside the range. Outside the range. I showed you what happened if we are within the range. So now we're going to work an example that it is within the range, because here we have to kind of follow a few steps, like four steps. Make sure you know it's step one. Find the difference between the general 20% QBI and the W2 wages capital investment amount. So just basically what we just did, find the difference between them. Then we're going to calculate a ratio. It's something called a reduction percentage or reduction ratio. Step two. We're going to take taxable income before qualified business income deduction minus the threshold. And the threshold could be for either single or merit filing jointly divided by the range. The range for merit filing jointly. If your merit filing jointly is 100,000, for a single is 50,000. Step three. Find the reduction in W2 wages slash capital investment limit. Simply put, take step one times step two. Step four. Calculate now the QBI, which is taking 20% of QBI deduction minus what we got in step three. Too many steps, right? Let's work an example. We're going to be working with Noah and Mia again. Assume Noah and Mia, remember they own the restaurant and they have some employees. So let's change some numbers. We're going to assume their taxable income is 406,200. What's the special about 406,200? It's above. It's between the two threshold, the upper and the lower threshold. It's in the middle. Qualified business income is 300,000. W2 wages are 100,000. Unadjusted basis in the property. We're going to keep it the same 520. So let's start with step one. Step one. Find the difference between the general 20% QBI, which is QBI is 300,000 times 20%, and W2 wages, you know, the 25% or 50% the greater of these two. So this is the 20% of QBI minus, 50% of 100,000 in wages, which is 50,000, or notice here, or 100,000 in wages times 25% plus 2.5 of 520 times 520. If we do this computation, whatever this number, this number is going to be lower than 50. Therefore we'll choose 50. So it's going to be 60,000 minus 50,000. 60,000 is 300,000 times 20. So we found step one, which is what? Find the difference between the general 20% QBI and the W2 wages capital investment amount, which is right here. Remember this step, it involves two computation, and we'll choose the greater of the two. We're done with step one. Step two, calculate the reduction ratio or the reduction percentage. How do we do that? We'll take taxable income before QBI. Do we have this? Yes. We have taxable income before QBI of 406,200, and we're going to deduct from it the threshold for Adam and Noah, which is married fighting jointly, and we're going to divide this by the range of married fighting jointly. 406,200 minus 362,200 divided by, that's going to give us 44,000, divided by 100,000. The ratio is 44%. Done with step two. Step three, find the reduction. I highly doubt that you will be giving something like this on the CPA exam, okay? But in your accounting course, you will know it, and if you know this, you'll be able to answer any questions on the CPA exam. Step three, find the reduction in W2 wages, which is taken step one times step two easy. Step one times 1,000 times step two is 44%, and that's going to be the reduction in your W2 wages. Now, step four, take 20% of your QBI, 20% of your QBI minus the reduction in step three. Well, 60,000, which is 20% of QBI, time minus the 4,400 step three. Now, overall, remember, we cannot exceed, I did not do the computation here, let me do it. Let's take our modified adjustable income, 406,200 times 0.2, we cannot exceed 81,240, which we did not, 55,600. So what I did in this session is basically went over this limitation. So I just want to make sure you understand where we are here now and where we are heading. So in this session, I looked at when we have a high income. In the next session, we'd look at the third limitation that applied to certain types of service businesses. Remember, SSBs, now we'll focus on those. Qualified business income deduction is an important topic, whether you are an accounting student, CPA candidate, enrolled agent, Farhat Lectures, that's what you should do now. Go to Farhat Lectures, look at additional lectures, MCQs, true, false, notes. That's going to help you do what? To understand this concept better. Invest in yourself, study hard, it's worth it, and of course, stay safe.