What Is Qualified Business Income & How Does It Work?

Defining Qualified Business Income

Qualified Business Income (QBI) represents the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. This calculation is performed separately for each qualified trade or business operated by a taxpayer. QBI is not simply gross revenue, but rather the taxable income remaining after relevant deductions.

QBI is a specific tax term under Section 199A of the U.S. tax code, designed to provide a deduction for owners of pass-through entities. These entities typically include sole proprietorships, partnerships, and S corporations. Income from these structures flows through directly to the owner’s personal tax return, where QBI is determined. Understanding this net figure is essential, as it directly impacts the maximum amount of the deduction available to business owners.

Income Included in Qualified Business Income

When calculating Qualified Business Income, various operational elements of a trade or business are considered. This includes the ordinary income a business earns from its primary activities, such as revenue generated from selling goods or providing services.

Routine business expenses and deductions directly related to the trade or business also factor into the QBI calculation. These can include costs such as rent for business premises, utility payments, and the expense of supplies necessary for operations. Wages paid to employees are another important element that reduces the overall QBI. Depreciation expenses on business assets, along with the cost of goods sold, are further examples of deductions that reduce the net QBI amount. All these items collectively reflect the true net profitability of a qualified trade or business.

Income Excluded from Qualified Business Income

Certain types of income, gains, deductions, and losses are specifically excluded from the calculation of Qualified Business Income. This distinction is important for accurately determining the QBI deduction. Investment income, for instance, does not count as QBI.

This exclusion covers items such as capital gains or losses from the sale of property not used in the ordinary course of business. Similarly, dividends received, interest income not directly associated with the trade or business, and annuity income are all excluded. These are generally considered passive income sources rather than active business earnings.

Furthermore, wages received by an individual as an employee are not considered QBI. For S corporation shareholder-employees, any reasonable compensation paid to them is excluded from QBI. Guaranteed payments made to a partner in a partnership for services rendered are also explicitly excluded from QBI.

Qualified Businesses and Specified Service Trades or Businesses

A “qualified trade or business” for QBI purposes generally encompasses any trade or business that is not a specified service trade or business (SSTB). Most common business activities, ranging from manufacturing to retail, are typically considered qualified. This broad definition means many small business owners and self-employed individuals may be eligible for the QBI deduction.

Specified Service Trades or Businesses (SSTBs) are a distinct category with specific limitations on the QBI deduction. These are businesses where the performance of services in certain fields is the primary activity. Examples include businesses in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.

An SSTB also includes any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. This broad definition ensures that highly compensated service professionals face limitations on the QBI deduction. While an SSTB can still generate QBI, its eligibility for the deduction depends heavily on the taxpayer’s overall taxable income.

Calculating the Qualified Business Income Deduction

The calculation of the Qualified Business Income (QBI) deduction, also known as the Section 199A deduction, involves several steps and limitations based on a taxpayer’s taxable income. The basic premise allows eligible taxpayers to deduct up to 20% of their QBI. However, this deduction is subject to various thresholds and rules.

For the 2024 tax year, if a taxpayer’s taxable income (before the QBI deduction and net capital gains) is at or below $191,950 for single filers or $383,900 for married filing jointly, the deduction is generally 20% of QBI. In this income range, income from a Specified Service Trade or Business (SSTB) is treated the same as income from any other qualified business, without additional limitations related to the SSTB designation. The deduction cannot exceed 20% of the taxpayer’s taxable income (minus net capital gains).

When a taxpayer’s taxable income falls within the phase-in range, which for 2024 is between $191,951 and $241,950 for single filers or $383,901 and $483,900 for married filing jointly, additional limitations begin to apply. Within this range, the deduction becomes subject to the W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property. For SSTBs, the QBI deduction begins to phase out within this range, meaning the deduction is gradually reduced or eliminated as income approaches the upper threshold.

For taxpayers with taxable income above the upper threshold of $241,950 for single filers or $483,900 for married filing jointly in 2024, the W-2 wages and UBIA of qualified property limitations apply fully. The deduction is limited to the lesser of 20% of QBI or the greater of 50% of the W-2 wages paid by the business, or 25% of W-2 wages plus 2.5% of the UBIA of qualified property. Furthermore, at these higher income levels, income from an SSTB is completely excluded from QBI for purposes of the deduction, meaning no QBI deduction is available for SSTB income.

The W-2 wages and UBIA limitations aim to encourage businesses that employ workers and invest in tangible assets. Qualified property generally refers to depreciable tangible property held by the business at the end of the tax year and used in the production of QBI. If a taxpayer has multiple qualified businesses, the QBI, W-2 wages, and UBIA from each business are generally aggregated to determine the overall deduction, subject to the various limitations and thresholds.