Calculating Your Qualified Business Income Component

The Section 199A deduction, set to expire for tax years after 2025, provides a tax break for owners of many pass-through businesses, such as sole proprietorships, partnerships, and S corporations. The deduction’s central element is the qualified business income (QBI) component.

Calculating this component is the first step in determining the overall deduction. The process involves calculating the business’s income, applying a percentage, and for some taxpayers, navigating limitations based on income, employee wages, and property investments.

Determining Your Qualified Business Income

A “qualified trade or business” (QTB) refers to nearly any trade or business, with the primary exceptions being the trade or business of being an employee or operating as a C corporation. Once a business is identified as a QTB, its qualified business income is calculated, which represents the net profit eligible for the deduction.

The calculation starts with the gross income from the business’s primary activities, such as revenue from sales or fees for services. From this income, ordinary business deductions are subtracted, including expenses like rent, supplies, and salaries paid to non-owner employees.

Certain items are specifically excluded from the QBI calculation. These include W-2 wages paid to an S corporation owner-employee, capital gains or losses, and portfolio income like interest and dividends. For example, if a consulting firm has $150,000 in service revenue and $60,000 in deductible expenses, its QBI is $90,000; any interest earned on the business’s bank account is excluded.

If a taxpayer has multiple businesses, the QBI for each is determined separately. If one business has a QBI loss, that loss must be allocated proportionately among the profitable businesses, reducing their QBI amounts.

Calculating the Initial QBI Component

The initial calculation of the QBI component is straightforward: it is 20% of the QBI calculated for the trade or business. For a significant number of taxpayers, this initial calculation will also be their final QBI component amount.

Using the previous example of a consulting firm with a QBI of $90,000, the initial QBI component would be $18,000. This amount represents the preliminary deduction before considering limitations that apply to higher-income taxpayers.

Applying the W-2 Wage and UBIA of Qualified Property Limitations

The initial 20% QBI component may be reduced if a taxpayer’s taxable income before the QBI deduction exceeds certain thresholds. For the 2025 tax year, these thresholds are $197,300 for single and other filers and $394,600 for those married filing jointly.

The limitation formulas use two factors. The first is “W-2 wages,” which are total wages subject to withholding paid to employees that are allocable to QBI. The second is the “Unadjusted Basis Immediately after Acquisition” (UBIA) of qualified property, which is the original cost of tangible, depreciable property like buildings and machinery.

For taxpayers above the income thresholds, the QBI component is limited to the lesser of the initial 20% of QBI or the greater of two separate tests. The first test is 50% of the W-2 wages. The second test is 25% of the W-2 wages plus 2.5% of the UBIA of qualified property. For instance, a business with $150,000 in QBI has an initial component of $30,000. If it has $40,000 in W-2 wages, the wage limitation is $20,000 (50% of wages). Because the wage limitation is less than the initial component, the QBI component is reduced to $20,000.

A phase-in range exists for taxpayers with income between the lower and upper thresholds, extending up to $247,300 for single filers and $494,600 for joint filers. Stricter rules apply to a “Specified Service Trade or Business” (SSTB), such as health, law, and consulting. For an SSTB, the deduction is phased out for taxpayers with income in this range and disallowed for those above the upper threshold.

Aggregation of Multiple Trades or Businesses

Taxpayers who own more than one qualified trade or business may be able to make an aggregation election. This allows an individual to treat two or more businesses as a single entity for calculating the QBI deduction. This election is binding for future tax years unless there is a significant change in circumstances.

To be eligible for aggregation, the same person or group must own 50% or more of each business, and all businesses must share the same tax year-end. The businesses must also demonstrate operational integration, such as sharing facilities or offering complementary services.

The purpose of aggregation is to maximize the QBI component by overcoming the W-2 wage and UBIA limitations. Combining the QBI, W-2 wages, and UBIA from multiple businesses can result in a higher deduction. For example, a business with high QBI but low wages can be combined with one that has lower QBI but significant wages, allowing the wages from the second business to support a larger deduction.

Required Information and Reporting

To calculate the QBI component, you will need the final QBI amount, total allocable W-2 wages, and the UBIA of qualified property for each business. If an aggregation election is made, these figures must be combined for the aggregated group. This information is reported to the IRS on forms attached to your annual Form 1040.

Taxpayers with taxable income below the established thresholds use Form 8995, Qualified Business Income Deduction Simplified Computation. Those with income above the thresholds, who are aggregating businesses, or have more complex situations must file Form 8995-A, Qualified Business Income Deduction.

Form 8995-A is more detailed, requiring the taxpayer to report the QBI, W-2 wages, and UBIA for each business to complete the limitation and aggregation calculations. The result from either form is entered on the appropriate line of the Form 1040.