How to Qualify for QBI and Claim the Deduction

The Qualified Business Income (QBI) deduction allows eligible business owners to deduct up to 20% of their qualified income, reducing taxable income and overall tax liability. Introduced in the Tax Cuts and Jobs Act of 2017, this deduction applies to many pass-through entities, including sole proprietorships, partnerships, S corporations, and certain trusts and estates.

Qualifying requires meeting specific criteria related to business type, income level, and other restrictions. Understanding these requirements ensures business owners maximize their deduction while staying compliant with IRS rules.

Types of Businesses That Qualify

The QBI deduction applies to pass-through entities, meaning the business’s income is reported on the owner’s personal tax return rather than being taxed at the corporate level. This includes sole proprietorships, partnerships, S corporations, and certain trusts and estates. These structures allow business profits to “pass through” to the owner, who then pays individual income tax on the earnings.

Only domestic income qualifies, so earnings from foreign operations are excluded. The income must come from an active trade or business rather than investment-related activities. Rental real estate businesses may qualify if they meet the IRS’s definition of a trade or business, which generally requires regular and continuous involvement in property management.

A manufacturing company structured as an S corporation can claim the deduction on its net business income, while a real estate investor operating as a sole proprietor must demonstrate active participation to qualify. Businesses generating income through product sales, service-based operations, or consulting can claim the deduction if they meet the necessary requirements.

Income Threshold Considerations

The QBI deduction is subject to income limitations. For 2024, the deduction begins to phase out for individuals with taxable income exceeding $191,950 for single filers and $383,900 for married couples filing jointly. Beyond these levels, additional restrictions can reduce or eliminate the deduction.

For taxpayers below these thresholds, up to 20% of qualified business income can be deducted. Once income exceeds the phase-in range, wage and capital restrictions limit the deduction to the lesser of 20% of QBI or the greater of: (1) 50% of W-2 wages paid by the business or (2) 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property. Business owners with few employees or minimal capital investment may see their deduction reduced if they exceed the income threshold.

High-income earners can use tax planning strategies to stay within the limits or mitigate the phaseout’s impact. Maximizing retirement contributions, accelerating deductions, or deferring income to future years can help keep taxable income below the threshold. Structuring compensation and business expenses efficiently can also help preserve the deduction.

Specified Service Trade or Business Criteria

Certain businesses face additional scrutiny when determining eligibility. The IRS designates specific industries as Specified Service Trades or Businesses (SSTBs), which include professions where the principal asset is the skill or reputation of employees or owners. These fields include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. If a business falls into one of these categories, its ability to claim the deduction becomes more restrictive as taxable income rises.

For 2024, single filers with taxable income above $241,950 and married couples filing jointly above $483,900 cannot claim the deduction if their business qualifies as an SSTB.

Distinguishing between an SSTB and a non-SSTB can be complex, especially for businesses providing both specified and non-specified services. For example, an architectural firm that primarily designs buildings but also offers consulting on zoning regulations may need to separate its income sources. The IRS allows businesses to bifurcate revenue streams if at least 50% of gross receipts come from activities that do not fall under SSTB classification. If structured properly, a portion of the business may still qualify for the deduction.

Exclusions That May Restrict Eligibility

Certain types of income and business arrangements prevent taxpayers from claiming the QBI deduction. Investment income does not qualify, including capital gains, dividends, interest income (unless derived from a lending business), and annuity payments not connected to a trade or business. A financial advisor earning fees from client services may qualify, but dividends received from personal stock holdings would not contribute to QBI.

Business owners receiving guaranteed payments or reasonable compensation from an S corporation also face limitations. Wages paid to an owner-employee of an S corporation do not count as QBI, even if derived from active business operations. Similarly, guaranteed payments to partners in a partnership are excluded, as they are considered compensation for services rather than pass-through business income. Structuring owner compensation effectively can influence overall tax liability.

Calculating the Deduction

Determining the QBI deduction requires a multi-step calculation based on taxable income, business structure, and wage or property limitations. While generally 20% of QBI, additional factors can reduce the final amount, particularly for high-income earners or those in specified service trades or businesses.

For taxpayers below the income threshold, the deduction is 20% of QBI, subject to an overall limit of 20% of taxable income minus capital gains. Once income exceeds the phase-in range, the deduction is restricted by W-2 wages and qualified property. If a business has no employees, the deduction may be limited to 2.5% of the unadjusted basis of depreciable assets. A rental property owner with $500,000 in depreciable assets could claim a maximum deduction of $12,500 (2.5% of $500,000) if wage limitations apply. Those with employees may benefit from the 50% wage threshold, meaning a business paying $200,000 in wages could claim up to $100,000 in deductions under this rule.

Pass-through businesses with multiple income sources must allocate QBI correctly. If a taxpayer owns multiple qualifying businesses, each entity’s QBI must be calculated separately before applying the deduction. Aggregation rules allow certain businesses under common ownership to be combined for deduction purposes, potentially increasing the allowable amount. Adjusting compensation structures or capital investments can help maximize the deduction while ensuring compliance with IRS regulations.

Documentation Essentials

Maintaining proper documentation is necessary to substantiate the QBI deduction in case of an IRS audit. Since the deduction relies on business income, wages, and property values, taxpayers must keep detailed records supporting their calculations and eligibility.

For businesses with employees, payroll records are essential to verify W-2 wages, which impact the deduction for those above the income threshold. Taxpayers should retain year-end payroll summaries, tax filings such as Form W-3, and quarterly tax reports. Those relying on the 2.5% property basis rule must keep depreciation schedules, purchase agreements, and fixed asset registers to confirm the unadjusted basis of qualified property. In cases where businesses aggregate multiple entities, documentation demonstrating common ownership and operational interdependence is required.

Pass-through entities must also provide owners with accurate tax reporting forms. Partnerships and S corporations issue Schedule K-1 to report each owner’s share of QBI, wages, and other relevant figures. Taxpayers should ensure these forms align with their personal tax filings to avoid discrepancies. Proper bookkeeping, financial statements, and tax return workpapers further support compliance, reducing the risk of disallowed deductions during an audit.