How Much Is the Qualified Business Income Deduction?

The Qualified Business Income (QBI) deduction, formally known as Section 199A of the Internal Revenue Code, offers a significant tax benefit to eligible self-employed individuals and small business owners. This deduction emerged from the Tax Cuts and Jobs Act (TCJA) of 2017, aiming to provide tax relief for owners of pass-through entities. It allows qualifying taxpayers to deduct up to 20% of their qualified business income, lowering their taxable income. The QBI deduction is taken on an individual’s tax return and is available whether a taxpayer chooses to itemize deductions or take the standard deduction.

Eligibility for the QBI Deduction

The QBI deduction is specifically designed for owners of pass-through entities, which include sole proprietorships, partnerships, S corporations, and certain trusts and estates. These business structures do not pay corporate income tax themselves; instead, their income “passes through” directly to the owners’ personal tax returns, where it is subject to individual income tax rates. The deduction applies to “qualified business income” (QBI), which generally represents the net amount of income, gain, deduction, and loss from a qualified trade or business conducted within the United States.

Certain types of income are specifically excluded from QBI. These exclusions include wage income, capital gains or losses, and interest income not directly related to the trade or business. Additionally, reasonable compensation paid to an S-corporation shareholder and guaranteed payments to a partner are not considered QBI.

The deduction also considers the nature of the business, particularly whether it is a “specified service trade or business” (SSTB). An SSTB is broadly defined as any trade or business involving the performance of services in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. It also includes any business where the principal asset is the reputation or skill of one or more of its employees or owners.

Calculating Your Qualified Business Income Deduction

The initial calculation of the Qualified Business Income (QBI) deduction follows a straightforward rule: it is generally the lesser of 20% of your qualified business income or 20% of your taxable income before the QBI deduction, but after any net capital gains. For instance, if a qualified business generates $100,000 in QBI and the taxpayer’s taxable income before the QBI deduction is $120,000, the potential deduction would be $20,000 (20% of $100,000).

Qualified business income encompasses the deductible portion of self-employment tax, self-employed health insurance premiums, and contributions to qualified retirement plans like SEP IRAs or SIMPLE IRAs. However, it specifically excludes items such as investment income and certain dividends. Income earned outside the U.S. from foreign businesses is also not included in QBI.

To illustrate, consider a sole proprietor with $75,000 in qualified business income and a total taxable income (before the QBI deduction) of $80,000. In this scenario, the QBI deduction would be calculated as the lesser of 20% of $75,000 ($15,000) or 20% of $80,000 ($16,000). The taxpayer would therefore be eligible for a $15,000 QBI deduction, which directly reduces their taxable income. This basic calculation applies to taxpayers whose income falls below specific thresholds, where more complex limitations related to W-2 wages and the unadjusted basis of qualified property (UBIA) do not yet apply.

Income and Business Type Limitations

The amount of the Qualified Business Income (QBI) deduction can be significantly reduced or even eliminated based on a taxpayer’s total taxable income and whether their business is classified as a specified service trade or business (SSTB). These limitations are triggered when a taxpayer’s taxable income exceeds certain thresholds, which are adjusted annually for inflation. For 2024, the lower taxable income threshold is $191,950 for single filers and $383,900 for those married filing jointly. The deduction begins to phase out within a range above these thresholds.

For taxpayers whose taxable income is above the lower threshold, the QBI deduction becomes subject to a W-2 wage and unadjusted basis of qualified property (UBIA) limitation. In this scenario, the deduction is limited to the lesser of 20% of QBI or the greater of two amounts: 50% of the W-2 wages paid by the business, or 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property. W-2 wages refer to the total wages paid by the business to its employees for the year. UBIA of qualified property includes the unadjusted basis of tangible depreciable property, such as buildings, machinery, and equipment, used in the business to produce QBI.

The rules for specified service trades or businesses (SSTBs) introduce another layer of complexity. If a taxpayer’s taxable income is below the lower threshold, an SSTB is treated like any other qualified business, and the full 20% QBI deduction may be available. However, if taxable income falls within the phase-in range (for 2024, between $191,951 and $241,950 for single filers, and $383,901 and $483,900 for joint filers), the deduction for an SSTB is gradually reduced. Once taxable income exceeds the upper threshold (for 2024, $241,950 for single filers and $483,900 for joint filers), the QBI deduction for income derived from an SSTB is completely eliminated. This means that high-income professionals in fields like law or accounting may find their QBI deduction significantly limited or entirely disallowed.