Is the Qualified Business Income (QBI) deduction computed with or without the Standard Deduction removed from business income?

Question

I received a notice from the IRS this month:

We changed the amount claimed as your Qualified Business Income Deduction because there was an error in the computation.

The difference is in the thousands for the deduction (lower), and in the hundreds for what I owe (higher). I reread the instructions, redid the worksheet, and now I think I missed something. On page 34 of the general instructions for 1040 for 2018, Determining Your Qualified Business Income:

Your qualified business income includes items of income, gain, deduction, and loss from your trades or businesses that are effectively connected with the conduct of a trade or business within the Unites States. . . . It also includes other deductions attributable to the trade or business including, but not limited to, deductible tax on self-employment income, self-employed health insurance, and contributions to qualified retirement plans.

In other words, I should have reduced my Business Income by the amounts of business-related deductions to get the QBI. I neglected to do that for the self-employment tax deduction. That was my mistake. They don't explain how they computed the change to my numbers, but after tinkering a while their numbers agree perfectly with the theory that the IRS thinks I should also remove the standard deduction from my Business Income before calculating the QBI deduction.

That's a big difference. The standard deduction for single taxpayers is $12,000 for 2018, so that can lower the QBI deduction by $2400 (20%).

I don't think this is correct. The instructions say to include deductions attributable to the trade or business and then explicitly deductible tax on self-employment income. But nowhere does it mention the standard deduction. It seems to me a stretch that the standard deduction should also be removed from the QBI. How can that be attributable to my business when the same amount applies to all (single) taxpayers?

(Called the number in the letter. After 50 minutes on hold a guy transferred me to another department. Estimated wait time 30-60 minutes. Hung up. Now I intend to write.)

Answer 1

I think I found the answer. The tricky QBI worksheet line 11 asks for "Taxable income before qualified business income deduction". This goes into computing the limit to the QBI deduction. This is clarified in the instructions for worksheet line 11, on page 36 of the general instructions (for 2018 form 1040):

Line 11 [of the QBI Deduction Simplified Worksheet]. Taxable income before qualified business income deduction. Enter your taxable income figured before any qualified business income deduction. Adjusted gross income, Form 1040, line 7, minus standard deduction or itemized deductions from Form 1040, line 8.

(Emphasis mine.) In other words, QBI is limited by the AGI minus the standard deduction. The answer was there all along, I just missed it three times.

Another clue comes from this financial blogger:

Example 2: You earn $80,000 in sole proprietorship qualified business income but you also use the $24,000 married-filing-jointly standard deduction. In this case, your taxable income equals $56,000. You don’t get a Section 199A [Qualified Business Income] deduction equal to 20% of the $80,000 of qualified business income ($16,000) but instead get a Section 199A deduction equal to 20% of $54,000 [sic] ($10,800).

So he also removes the standard deduction before computing the QBI. So my answer is: Qualified Business Income is computed with the standard deduction removed from Business Income. But use the worksheet, because capital gains is in there too. And then check your work more than three times.

Answer 2

You don't get a standard deduction on your business income (the stuff you report on Schedule C). What you get to deduct from the income reported on Schedule C are the business expenses. The standard deduction is taken on Form 1040 and reduces the Adjusted Gross Income (AGI) (which includes the net Schedule C income). If you deducted $12K as the standard deduction on Schedule C itself, you are, in effect, double-dipping by deducting $12K twice, once on Schedule C and once on Form 1040.