What Is a Qualified Business Deduction?

The Qualified Business Deduction (QBD) offers a significant tax benefit for many business owners, reducing their federal income tax liability. Enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA), the QBD provides tax relief for individuals operating pass-through entities. It allows eligible business owners to deduct up to 20% of their qualified business income.

What is the Qualified Business Deduction

The Qualified Business Deduction (QBD), also known as the Section 199A deduction, allows eligible taxpayers to deduct a portion of their business income. This “below-the-line” deduction reduces a taxpayer’s taxable income without affecting their Adjusted Gross Income (AGI). It is available regardless of whether the taxpayer itemizes deductions or takes the standard deduction.

The core of this deduction revolves around “Qualified Business Income” (QBI). QBI is generally defined as the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business conducted within the United States. This typically includes the net profit from a sole proprietorship, partnership, or S corporation.

Certain income types are excluded from QBI:
Capital gains or losses
Dividends
Interest income (unless directly related to the business)
Income earned outside the U.S.
Employee wages
Reasonable compensation paid to an S corporation owner
Guaranteed payments made to a partner for services rendered

Eligibility for the Qualified Business Deduction

Eligibility for the Qualified Business Deduction extends primarily to individuals, trusts, and estates that hold interests in pass-through entities. These entities include sole proprietorships, partnerships, S corporations, and certain Limited Liability Companies (LLCs) taxed as such. C corporations are not eligible for this deduction, as they received separate tax rate reductions under the TCJA.

A taxpayer’s ability to claim the QBD is subject to limitations based on their total taxable income, which includes all income sources, not just business income. There are two main income thresholds that determine how the deduction is applied. For taxpayers whose taxable income is below the lower threshold, the deduction is generally straightforward, allowing up to 20% of their QBI without many complex limitations. For tax year 2025, the lower threshold is $197,300 for single filers and $394,600 for joint filers, with these amounts adjusted annually for inflation.

The type of business also plays a significant role in eligibility, particularly once taxable income exceeds the lower threshold. A “qualified trade or business” for QBD purposes is broadly defined as any trade or business other than a “Specified Service Trade or Business” (SSTB). SSTBs are businesses primarily involving services in fields such as:
Health
Law
Accounting
Actuarial science
Performing arts
Consulting
Athletics
Financial services
Brokerage services
Any business where the principal asset is the reputation or skill of its employees or owners can also be an SSTB.

For taxpayers whose income falls within the phase-out range, which is between the lower and higher income thresholds, the deduction for SSTBs begins to be limited. As taxable income increases within this range, the QBD for SSTBs is gradually reduced and eventually eliminated once the higher threshold is reached. For non-SSTBs, additional limitations based on W-2 wages and qualified property apply within this phase-out range.

Calculating the Deduction Amount

The calculation of the Qualified Business Deduction is typically the lesser of 20% of the taxpayer’s Qualified Business Income (QBI) or 20% of their taxable income before the QBD and any net capital gains.

For taxpayers whose taxable income exceeds the lower threshold, additional limitations apply to the deduction amount. One significant limitation involves the W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property. For each qualified business, the QBD is limited to the lesser of 20% of QBI from that business or the greater of two amounts: either 50% of the W-2 wages paid by the business, or the sum of 25% of the W-2 wages plus 2.5% of the UBIA of qualified property. The UBIA generally refers to the original cost of depreciable tangible property used in the business, such as buildings and equipment, without reduction for depreciation. This limitation is particularly relevant for businesses with high income but low W-2 wages or limited qualified property.

These W-2 wage and UBIA limitations are fully phased in once a taxpayer’s income surpasses the higher taxable income threshold. For Specified Service Trades or Businesses (SSTBs), the deduction is reduced and eventually eliminated as income increases within the phase-out range, reaching zero once taxable income hits the higher threshold.

Taxpayers who own multiple qualified businesses may find it advantageous to aggregate them for QBD purposes. Aggregation allows taxpayers to combine the QBI, W-2 wages, and UBIA of qualified property from multiple businesses, which can help them meet the W-2 wage and UBIA limitations and potentially maximize their overall deduction. However, this election is not automatic and typically requires adherence to specific IRS guidelines, such as common ownership and integrated operations.

Reporting the Deduction and Tax Implications

Once the Qualified Business Deduction amount is determined, it is reported on the individual’s federal income tax return. The deduction is typically claimed directly on Form 1040, often on a specific line within Schedule 1 (Additional Income and Adjustments to Income). To calculate and substantiate the deduction, taxpayers generally use IRS Form 8995, “Qualified Business Income Deduction Simplified Computation,” or Form 8995-A, “Qualified Business Income Deduction.” Form 8995 is used by most taxpayers with income below certain thresholds, while Form 8995-A is for those with higher income or more complex situations.

The primary tax implication of the QBD is a direct reduction in the taxpayer’s taxable income. As a “below-the-line” deduction, it reduces the amount of income subject to tax after Adjusted Gross Income (AGI) is calculated. This reduction in taxable income directly lowers the individual’s overall income tax liability.

The Qualified Business Deduction reduces federal income tax but does not reduce self-employment tax. Self-employment tax, which covers Social Security and Medicare contributions for self-employed individuals, is calculated based on net self-employment earnings before the QBD is applied. Therefore, while the deduction provides significant income tax savings, it does not impact a taxpayer’s contributions to these social insurance programs.