QBI Distributions Or Qualified Dividends, Which Is Better?

by: D.S. Leach & C.E. Leach

The last article I published briefly explained Qualified Business Income (QBI) as introduced in the latest Federal income tax legislation.

Tax payers are allowed to deduct 20% of their QBI from their taxable income which results in a lower effective tax rate.

QBI includes several types of pass-through income from sole proprietorships, partnerships, S-corporations, REIT ordinary dividends, and MLP income distributions.

This article takes a more detailed look at QBI effective rates, including a comparison with the rates on qualified dividends.


The Tax Cuts and Jobs Act (TCJA) of 2017 allows many tax payers to exclude 20% of their Qualified Business Income (QBI) from their taxable income. This results in a lower effective tax rate on QBI. Since QBI includes several types of pass-through income (e.g. sole proprietorship, partnership, S-Corporations, REIT, and MLP), many investors and business owners are going to get a decent additional tax break for 2018 and beyond. My last article, published on Seeking Alpha, covered the QBI deduction in more detail. This article takes a more detailed look at the effective tax rates provided by the 20% QBI deduction, including a comparison with tax rates on qualified dividends.

Effective Tax Rates For QBI

The TCJA (section 199A) allows taxpayers with qualifying pass-through business income (i.e., QBI) to deduct 20% of their QBI from their taxable income before the calculation of federal taxes owed. This effectively lowers the tax rate on QBI. The calculation below provides a conceptual summary.

For this example, let us assume the taxpayer's 2019 taxable income before QBI deduction is $120,000 and $10,000 of that is QBI.

- QBI deduction = 20% of $10,000 = $2000

- Final Taxable Income = $120,000 - $2000 = $118,000

- Tax calculation

10% of $9700 = $970

+ 12% of ($39,475 - $9,700) = $3,573

+ 22% of ($84,200 - $39,475) = $9,839.50

+ 24% of ($118,000 - $84,200) = $8,112

Total = $22,494.50

- Tax on $120,000 (without QBI deduction) = $22,974.50

- QBI Deduction Tax Savings = $480

That's a lot of math to find $480 in tax savings as a result of a $2000 QBI deduction. Fortunately, the QBI tax savings calculation can be simplified.

- QBI Deduction Tax Savings = 24% of $2,000 = $480

In other words, the taxpayer saved 24% of the $2,000 QBI deduction. We can also reflect the QBI deduction in terms of an effective tax rate on QBI income. Rather than look at the tax savings, we can look at the QBI income that is subject to tax after the 20% QBI deduction. In the above example, the taxpayer has $10,000 of QBI and is squarely in the 24% marginal tax bracket. After the QBI deduction, the taxpayer has $8,000 of QBI income that will be taxed at 24%.

- 24% of $8,000 = $1,920

This is equivalent to having an effective QBI tax rate of 80% of 24% or 19.2% which will give an equivalent tax owed on the total QBI ($10,000).

- 19.2% of $10,000 = $1,920

This is little more than mathematical gymnastics but it turns out to be pretty useful. It is useful because we can calculate an effective QBI marginal rate to go along with the standard IRS marginal rates and see how much the QBI deduction is really worth in terms of tax savings. The table below provides a one-to-one comparison of the IRS marginal rate, the QBI effective marginal rate, the difference between the two, and the qualified dividend tax rate. The individual and joint income brackets that correspond to those marginal rates are also shown in the table.

Source: Author

I think there are a couple of valuable nuggets from the table above. First, it is pretty clear from the QBI rate difference column that the QBI deduction becomes more valuable as the taxpayer's income increases. In the lowest bracket, the QBI deduction provides the taxpayer only a 2% reduction in marginal tax rate on QBI. In the highest bracket, the QBI deduction provides the taxpayer a 7.4% reduction in marginal tax rate on QBI. This is simply the result of taking a percentage (20%) of higher IRS marginal rates. In other words, 20% of 37% is bigger than 20% of 10%. I certainly don't know if that was what was intended by the authors of the TCJA legislation, but clearly, the QBI deduction is more valuable to high-income taxpayers.

Secondly, while the QBI deduction is valuable to all taxpayers, it is not as valuable as the preferential tax rate on qualified dividends. For example, let's compare the ordinary dividend (not qualified) from a REIT to a qualified dividend from a typical C-corp. For this example, I'll choose Iron Mountain (NYSE:IRM) and AT&T (NYSE:T). The dividend yields for these two equities are 6.81% for IRM and 6.6% for AT&T as of Friday's market close. The yields are not exactly equal but close enough to make the point. IRM typically pays out ordinary dividends (pass-through income) that is now eligible for a 20% QBI deduction. So, for a taxpayer in the 24% marginal tax bracket, the after-tax yield on IRM is 80.8% (100% -19.2%) of 6.81% or 5.5%. On the other hand, T typically pays out qualified dividends. The after-tax yield on T qualified dividends for the same taxpayer is 85% (100% - 15%) or 5.61%. So, even though IRM has a slightly higher untaxed yield and the investor will be getting a QBI deduction on IRM ordinary dividends, that same taxpayer will keep more of the qualified dividends from his investments in T.


Investment decisions should never be made solely based on income tax considerations. But... investors should be aware of the tax consequences of investment decisions including how dividend distributions are treated by the IRS. The TCJA legislation brings us a new deduction for pass-through income, including dividends/distributions from equities that pass income through to the investor untaxed at the corporate level (e.g. REITs and MLPs). The TCJA legislation offers investors the ability to shelter some categories of pass-through income from the tax collector.

In addition to T and IRM, I currently hold a significant number of REITs and MLPs in my personal portfolio. As of today, I hold Chatham Lodging Trust (NYSE: CLDT), Physicians Realty Trust (NYSE: DOC), Enterprise Products Partners (NYSE: EPD), Energy Transfer (NYSE: ET), The GEO Group (NYSE: GEO), Hannon Armstrong Sustainable Infrastructure Capital (NYSE: HASI), KNOT Offshore Partners (NYSE: KNOP), Realty Income (NYSE: O), Omega Healthcare Investors (NYSE: OHI), Sabra Health Care REIT (NASDAQ: SBRA), Starwood Property Trust (NYSE: STWD), Ventas (NYSE: VTR), Welltower, (NYSE: WELL), and Western Gas Partners (NYSE: WES). I'm looking forward to keeping a little more of dividends and distributions I received in 2018.

Disclaimer: This article is intended to provide my opinion to interested readers and to serve as a vehicle to generate informed discussion in the comment postings. I have no knowledge of individual investor circumstances, goals, portfolio concentration or diversification. Readers are strongly encouraged to complete their own due diligence on any stock, bond, fund or other investment mentioned in this article before investing.

Disclosure: I am/we are long IRM, CLDT, T, DOC, EPD, ET, GEO, HASI, KNOP, O, OHI, SBRA, STWD, VTR, WELL, WES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.