The QBI Deduction Phase Out Rules for 2023

The Qualified Business Income (QBI) deduction, established under Section 199A, offers a tax benefit for owners of pass-through entities, including sole proprietorships, partnerships, and S corporations. It allows for a deduction of up to 20% of the business’s qualified income, lowering the tax burden on profits passed to the owners’ personal tax returns.

The deduction directly reduces an owner’s adjusted gross income, resulting in a lower overall tax liability. However, its calculation is subject to rules based on the taxpayer’s income and business type.

Under current law, the QBI deduction is scheduled to expire after the 2025 tax year. Unless Congress passes new legislation to extend it, this deduction will not be available for tax years 2026 and beyond.

2025 Income Thresholds for the QBI Deduction

For the 2025 tax year, the Internal Revenue Service (IRS) has established taxable income thresholds that determine how the QBI deduction is calculated. These thresholds are indexed for inflation and are based on your taxable income before taking the QBI deduction. Your income level relative to these thresholds dictates whether the deduction is straightforward, subject to a phase-out, or fully limited.

The income thresholds vary by filing status. For 2025, the lower threshold is $197,300 for Single, Head of Household, or Married Filing Separately filers, and $394,600 for those who are Married Filing Jointly.

The upper income threshold is $247,300 for most filers and $494,600 for joint filers. If your income falls between these lower and upper thresholds, you enter a phase-out range where limitations are gradually applied.

Calculating the QBI Deduction Below the Threshold

For taxpayers whose 2025 taxable income is below the lower thresholds, the QBI deduction calculation is direct. In this scenario, the wage and property limitations do not apply, regardless of the type of business you operate. This straightforward calculation applies even if the business is a Specified Service Trade or Business (SSTB).

The deduction is calculated as the lesser of two amounts: 20% of your qualified business income, or 20% of your taxable income before the QBI deduction, reduced by any net capital gains.

For example, consider a single filer with $150,000 in taxable income before the QBI deduction, which includes $100,000 of qualified business income and no capital gains. The first calculation is 20% of $100,000, which is $20,000. The second is 20% of $150,000, which is $30,000. The taxpayer’s QBI deduction would be $20,000, the lesser of the two amounts.

The Phase-Out Calculation for Taxpayers Within the Thresholds

When a taxpayer’s income falls into the phase-out range, the calculation becomes more involved as limitations based on business wages and property are gradually introduced. The two limitations are based on W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property. UBIA represents the original cost of tangible, depreciable property used in the business. The first limitation is 50% of the W-2 wages paid, while the second is 25% of W-2 wages plus 2.5% of the UBIA of qualified property.

The nature of the business also becomes a factor. The rules distinguish between general businesses and Specified Service Trades or Businesses (SSTBs). SSTBs are fields where the principal asset is the reputation or skill of its employees, such as health, law, accounting, consulting, and financial services.

For a non-SSTB, the deduction begins with the standard 20% of QBI but is then reduced. This reduction is determined by how far the taxpayer’s income is into the phase-out range. The taxpayer calculates the difference between the simple 20% deduction and the full W-2/UBIA limitation amount. A percentage, based on their income level within the phase-out zone, of that difference is then subtracted from the initial 20% deduction to arrive at the final QBI deduction.

For an SSTB, as income moves through the phase-out range, the amount of QBI, W-2 wages, and UBIA that can be used in the calculation is proportionally reduced. For example, if a single filer is 40% of the way through the $50,000 phase-out range, they can only consider 60% of their QBI, W-2 wages, and UBIA when calculating the deduction. By the time their income reaches the top of the threshold, the allowable amounts have been reduced to zero.

Applying the Full Limitations Above the Threshold

Once a taxpayer’s 2025 taxable income surpasses the upper threshold, the phase-out calculations no longer apply and full limitations are enforced. The rules at this level depend entirely on whether the business is classified as an SSTB.

For a business that is not an SSTB, the QBI deduction is determined by the wage and property limitations. The deduction is calculated as the lesser of two figures: 20% of the QBI, or the greater of either the 50% of W-2 wages limitation or the 25% of W-2 wages plus 2.5% of UBIA limitation. For instance, if 20% of QBI is $60,000 and the wage/property limitation is $45,000, the deduction is capped at $45,000.

If the taxpayer’s income exceeds the top of the phase-out range and their income is from an SSTB, the QBI deduction is zero. There is no calculation to perform or partial deduction to claim. The law completely disallows the deduction for owners of specified service businesses once their personal taxable income reaches this high level.