What Are Qualified Business Income Deductions?

The Qualified Business Income (QBI) deduction, often referred to as the Section 199A deduction, was introduced as part of the Tax Cuts and Jobs Act (TCJA) of 2017. This provision, codified under Internal Revenue Code Section 199A, aims to reduce the tax burden on certain pass-through entities and sole proprietorships. The deduction allows eligible taxpayers to reduce their taxable income by up to 20% of their QBI.

Its purpose is to provide a comparable tax benefit to non-corporate businesses, such as sole proprietorships, partnerships, and S corporations, similar to the reduced corporate tax rate C corporations received under the TCJA. This deduction is significant for small business owners and self-employed individuals, as it can substantially lower their federal income tax liability. The QBI deduction is set to expire at the end of 2025 unless Congress extends or modifies it.

Qualified Business Income Explained

Qualified Business Income (QBI) represents the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business. This generally includes the ordinary income a business generates, such as from partnerships, S corporations, and sole proprietorships.

Many common business deductions, including the deductible portion of self-employment tax, self-employed health insurance premiums, and contributions to qualified retirement plans like SEP or SIMPLE IRAs, are subtracted when calculating QBI. The QBI calculation focuses on the financial performance of the business itself, before considering the owner’s personal financial situation.

Certain types of income are specifically excluded from QBI. Investment income, such as capital gains or losses, dividends, and interest income, does not qualify. Income earned as an employee, including reasonable compensation paid to an S corporation shareholder-employee, is also not considered QBI. Similarly, guaranteed payments to a partner are excluded from QBI. These exclusions ensure the deduction primarily benefits active business operations rather than passive investment income or employment earnings.

Defining Qualified Trades or Businesses

A Qualified Trade or Business (QTB) for the QBI deduction generally refers to any trade or business that is not specifically excluded. This definition is broad and encompasses most typical business operations conducted as a sole proprietorship, partnership, or S corporation. Internal Revenue Code Section 162 provides a framework for what constitutes a trade or business.

A crucial exclusion from the definition of a QTB is the “trade or business of performing services as an employee.” This means individuals earning W-2 wages are not eligible for the QBI deduction on that income, even if their employer is a pass-through entity. The deduction is specifically designed for business owners and self-employed individuals.

Another significant exclusion involves “Specified Service Trades or Businesses” (SSTBs). These are businesses involved in performing services in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. The “reputation or skill” clause also designates any business where the principal asset is the reputation or skill of its employees or owners as an SSTB.

SSTBs are treated differently under the QBI deduction rules, particularly when a taxpayer’s income reaches certain thresholds. While an SSTB may qualify for the deduction at lower income levels, the deduction begins to phase out or is entirely eliminated once taxable income exceeds specific amounts. This distinction prevents high-income professionals in these fields from fully benefiting from the QBI deduction, creating a different set of rules for them compared to other QTBs.

Understanding Deduction Eligibility and Limitations

The QBI deduction is available to individuals, estates, and trusts, but not to C corporations. This distinction aligns with the deduction’s purpose of providing tax parity for pass-through entities. Taxpayers can claim this deduction regardless of whether they itemize deductions on Schedule A or take the standard deduction.

The applicability and amount of the QBI deduction are influenced by the taxpayer’s taxable income, which is calculated before considering the QBI deduction itself. There are two primary taxable income thresholds that determine how limitations apply. For tax year 2025, these thresholds are approximately $191,950 for single filers and $383,900 for joint filers (these amounts are adjusted annually for inflation). These are the lower thresholds where limitations begin to phase in.

When a taxpayer’s taxable income exceeds these lower thresholds, additional limitations based on W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property may apply. The W-2 wage limitation restricts the deduction to the greater of 50% of the W-2 wages paid by the qualified trade or business, or 25% of the W-2 wages plus 2.5% of the UBIA of qualified property. W-2 wages refer to the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the business. This limitation aims to tie the deduction to businesses with significant payrolls or tangible assets.

The UBIA of qualified property refers to the unadjusted basis of depreciable tangible property held by the qualified trade or business that is used in the production of QBI. This property must be subject to depreciation under Internal Revenue Code Section 167 and must be held by the business at the end of the tax year. The UBIA limitation provides a benefit to businesses that have substantial investments in assets, such as real estate or equipment.

For Specified Service Trades or Businesses (SSTBs), the QBI deduction begins to phase out once the taxpayer’s taxable income exceeds the lower threshold and is completely eliminated once taxable income reaches a higher threshold, which is approximately $241,950 for single filers and $483,900 for joint filers for 2025. For non-SSTBs, the W-2 wage and UBIA limitations apply fully once taxable income exceeds the lower threshold, but the deduction is not eliminated at the higher threshold.

An overall taxable income limitation also applies, stating that the total QBI deduction cannot exceed 20% of the taxpayer’s taxable income before the QBI deduction, reduced by any net capital gain. This ensures the deduction does not reduce taxable income beyond a certain proportion of the taxpayer’s overall income. These limitations are designed to target the deduction to specific income levels and business types.

Calculating Your Qualified Business Income Deduction

Calculating the Qualified Business Income (QBI) deduction involves a series of steps that integrate the various limitations. The process begins by determining the QBI for each qualified trade or business, summing all qualified items of income and subtracting all qualified deductions and losses attributable to that business.

Next, the taxpayer determines their total taxable income for the year, computed before any QBI deduction. This figure is crucial because it dictates which limitations will apply and to what extent. The initial potential deduction amount is 20% of the QBI from each qualified trade or business.

The next step involves applying the overall taxable income limitation. The total QBI deduction cannot exceed 20% of the taxpayer’s taxable income, reduced by any net capital gain. This acts as an upper bound for the deduction.

The taxpayer’s taxable income is then compared to the statutory thresholds. If the taxable income is below the lower threshold (e.g., approximately $191,950 for single filers or $383,900 for joint filers for 2025), the deduction is generally 20% of QBI or 20% of taxable income (minus net capital gain), whichever is less, and the W-2 wage and UBIA limitations do not apply. If the taxable income falls within the phase-in range between the lower and upper thresholds, the W-2 wage and UBIA limitations begin to apply proportionally.

For taxpayers with taxable income above the upper threshold (e.g., approximately $241,950 for single filers and $483,900 for joint filers for 2025), the W-2 wage and UBIA limitations apply fully. For non-Specified Service Trades or Businesses (SSTBs), the deduction is limited to the lesser of 20% of QBI or the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property. For SSTBs above this upper threshold, the QBI deduction is entirely eliminated.

The final deductible amount is the lowest figure derived from these various calculations and limitations. If a taxpayer has multiple qualified trades or businesses, the QBI, W-2 wages, and UBIA from each business are generally netted or combined according to specific rules before applying the limitations. The calculated QBI deduction is then reported on Form 1040, U.S. Individual Income Tax Return, typically on Schedule 1.