How Much Is the Qualified Business Income Deduction?

The Qualified Business Income (QBI) deduction, Section 199A of the Internal Revenue Code, offers a significant tax benefit for eligible business owners. This provision permits qualifying individuals to deduct up to 20% of their net QBI. It aims to provide a comparable tax reduction for owners of pass-through entities, such as sole proprietorships, partnerships, and S corporations, ultimately lowering the effective tax rate on business income for a broad range of taxpayers.

Defining Qualified Business Income

Qualified Business Income (QBI) represents the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. This generally includes ordinary income generated from business operations, such as that reported on a Schedule C for a sole proprietorship. Income passed through from partnerships and S corporations to their owners, typically reported on a Schedule K-1, also falls under the definition of QBI.

Certain types of income and deductions are specifically excluded from the definition of QBI. For instance, investment income, including capital gains or losses, dividends, and interest income not properly allocable to a trade or business, does not qualify. Additionally, reasonable compensation paid to an S-corporation shareholder for services rendered is not considered QBI. Guaranteed payments made to a partner for services or the use of capital, along with wages paid to an employee, are also explicitly excluded from this calculation.

Eligibility for the Deduction

The QBI deduction is primarily available to individuals, including those who own businesses directly or through pass-through entities, as well as certain trusts and estates. C corporations are not eligible to claim this deduction. The deduction benefits non-corporate taxpayers engaged in active business endeavors.

The deduction applies to income generated by qualified trades or businesses operating as pass-through entities. This includes common structures such as sole proprietorships, partnerships, and S corporations. Certain rental activities may also qualify if they are deemed to rise to the level of a trade or business under specific tax guidance.

A specific category of businesses known as Specified Service Trades or Businesses (SSTBs) is subject to unique rules under the QBI deduction. These businesses typically involve the performance of services in fields where the principal asset is the reputation or skill of one or more of its employees or owners. Examples of SSTBs include health, law, accounting, consulting, performing arts, athletics, financial services, and brokerage services. While SSTBs can generate QBI, their ability to claim the deduction is subject to limitations based on the taxpayer’s overall income.

How the Deduction is Calculated

The Qualified Business Income Deduction is 20% of the taxpayer’s Qualified Business Income. This initial amount is subject to an overall taxable income limitation. The deduction cannot exceed 20% of the taxpayer’s taxable income, calculated before considering the QBI deduction itself and any net capital gains.

For taxpayers whose taxable income exceeds certain thresholds, the deduction may become subject to additional limitations. These limitations are based on the W-2 wages paid by the qualified business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business.

W-2 wages include the total wages paid by the qualified trade or business to its employees for the tax year. This encompasses amounts reported on Form W-2, such as salaries, tips, and other compensation.

The Unadjusted Basis Immediately After Acquisition (UBIA) of qualified property refers to the original cost of tangible depreciable property used in the trade or business. This property must be held and available for use in the business at the close of the tax year and must have been used at some point during the year to produce QBI. This includes assets like buildings, machinery, and equipment.

When the taxable income exceeds the applicable threshold, the QBI deduction is limited to the lesser of two amounts. The first amount is 20% of the QBI. The second amount is the greater of (a) 50% of the W-2 wages paid by the qualified business, or (b) 25% of the W-2 wages paid by the qualified business plus 2.5% of the unadjusted basis immediately after acquisition of qualified property.

Income Thresholds and Special Rules

The Qualified Business Income deduction is impacted by a taxpayer’s taxable income, which determines whether certain limitations apply or are phased in. For the 2024 tax year, the lower taxable income threshold, where W-2 wage and UBIA limitations begin to apply, is $191,950 for single filers and those filing as head of household, and $383,900 for married taxpayers filing jointly. The upper threshold, where these limitations are fully phased in or the deduction for specified service trades or businesses (SSTBs) is eliminated, is $241,950 for single/head of household filers and $483,900 for married filing jointly.

For qualified businesses that are not SSTBs, if a taxpayer’s taxable income falls within the phase-in range, the W-2 wage and UBIA limitations are gradually applied. This means the deduction is not immediately subject to the full limitations but is proportionally reduced as income increases within this range.

Specified Service Trades or Businesses (SSTBs) face distinct rules based on the taxpayer’s income level. If a taxpayer’s taxable income is at or below the lower threshold, they can claim the full 20% QBI deduction for their SSTB income, subject only to the overall taxable income limitation.

If an SSTB owner’s taxable income falls within the phase-in range, the QBI from the SSTB is proportionally reduced. After this reduction, the W-2 wage and UBIA limitations are then applied to the remaining QBI.

Once a taxpayer’s taxable income exceeds the upper threshold ($241,950 for single/head of household, $483,900 for married filing jointly), no QBI deduction is permitted for income derived from an SSTB. At this income level, the deduction for specified service activities is completely phased out, regardless of the business’s W-2 wages or qualified property.

Taxpayers operating multiple qualified trades or businesses may be able to aggregate them for QBI deduction purposes. This aggregation can be beneficial, particularly in applying the W-2 wage and UBIA limitations.