Pass-through business taxes (QBI and S corp)

A pass-through business pays no income tax itself. Its profit flows to the owners and is taxed once, on their Form 1040. A single-member LLC reports on Schedule C, the same as a sole proprietor. A multi-member LLC files a partnership return and sends each owner a Schedule K-1. An S corp does the same with Form 1120-S.

Two rules then shape the bill. The qualified business income (QBI) deduction takes 20% off that profit before income tax, and it is now permanent. Self-employment tax charges Social Security and Medicare on 92.35% of the profit, at the same 15.3% that an employee and employer split on wages. Half of it is deductible from your income.

The thresholds are taxable income after the standard deduction and before the QBI deduction itself, not business profit. Below them the deduction is a flat 20% of QBI, capped at 20% of taxable income minus net capital gains. Above them the limits in the next section start to apply.

Any owner of a US trade or business that is not a C corporation: sole proprietors, LLC members, partners, S corp shareholders, and landlords who run their rentals as a business. Only net business profit counts, not wages you pay yourself, capital gains, interest, or dividends.

• Below the threshold: the full 20% deduction, whatever the business does.
• Specified service businesses above it: health, law, accounting, consulting, financial services, performing arts, athletics, and any business whose main asset is the owner's reputation or skill. The deduction phases out between $201,775 and $276,775 of taxable income ($403,500 to $553,500 joint) and is gone above that.
• Other businesses above it: the deduction is capped at the greater of 50% of the W-2 wages the business paid, or 25% of wages plus 2.5% of the original cost of its depreciable property. The cap phases in over the same range. A business with no employees and little equipment can lose most of the deduction.

By default, all of an LLC's profit is subject to self-employment tax. An S corp splits it. You pay yourself a reasonable salary through payroll, which carries Social Security and Medicare tax like any W-2 job. Whatever is left passes through as a distribution with no payroll tax. Both are ordinary income for income tax.

The trade-off is cost and paperwork: a payroll service, a separate Form 1120-S, W-2s, and in some states an entity-level tax or fee. The salary also shrinks your QBI, since wages are not qualified business income. The election tends to pay off once profit is well above a reasonable salary for your work.

$150,000 of profit, single filer, standard deduction, no other income. As a sole proprietor, self-employment tax is 15.3% of 92.35% of the profit, about $21,200. With an S corp election and an $80,000 salary, payroll tax is 15.3% of the salary, $12,240, and the rest passes through with no payroll tax. That saves about $8,950.

Income tax goes the other way. The salary is not qualified business income, so the QBI deduction falls from about $24,700 to about $12,800, and taxable income rises from about $98,600 to about $115,000, partly into the 24% bracket. That costs about $3,800 of income tax. Net saving: about $5,150 a year, less the S corp's own running costs.

• QBI deduction: Form 8995 if your taxable income is at or below the threshold, Form 8995-A if it is above. The result is a deduction on Form 1040, whether or not you itemize.
• Self-employment tax: Schedule SE, whether the profit comes from Schedule C or a partnership K-1. The deductible half goes on Schedule 1.
• S corp election: Form 2553, due by March 15 of the year you want it to start (for a calendar-year business). From then on the business files Form 1120-S, issues you a W-2 for the salary and a Schedule K-1 for the rest, and files quarterly payroll returns.