What Is the Section 198A Qualified Business Income Deduction?

The Qualified Business Income (QBI) deduction, also known as the Section 199A deduction, is a federal income tax deduction available to the owners of certain businesses. It was created under the Tax Cuts and Jobs Act of 2017 and allows eligible taxpayers to deduct up to 20% of their qualified business income from their taxable income. This provision was designed to provide a tax reduction for owners of pass-through entities, which are businesses where the income is “passed through” to the owner’s personal tax return rather than being taxed at the corporate level. The deduction is available to individuals, as well as certain trusts and estates, regardless of whether they take the standard deduction or itemize deductions on their tax return.

Determining Eligibility for the Deduction

Eligibility for the Qualified Business Income deduction hinges on several factors, including the type of business entity and the nature of the income earned. The deduction is specifically for pass-through businesses, which includes sole proprietorships, partnerships, and S corporations. Income earned by a C corporation or income received by an individual as an employee is not eligible for this deduction.

The core of eligibility rests on the definition of Qualified Business Income (QBI). QBI is the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business. This generally means the ordinary net income a business generates from its operations within the United States. The calculation starts with the net profit or loss from the business and is then adjusted for certain items.

Several types of income are specifically excluded from the definition of QBI and must be subtracted from the business’s net income. These exclusions include any wages earned as an employee, guaranteed payments made to a partner for services rendered, and most types of investment income. Specifically, capital gains and losses, dividends, and certain interest income are not considered QBI.

Calculating the Deduction Amount

The calculation of the Qualified Business Income deduction begins with a straightforward formula but can become more complex depending on the taxpayer’s income level and the nature of their business. For others, specific limitations based on income, the type of business, wages paid, and property owned will apply.

The Basic Calculation

For taxpayers whose taxable income before the QBI deduction falls below the annually adjusted thresholds, the deduction is the lesser of two amounts. The first amount is 20% of the taxpayer’s Qualified Business Income. The second is 20% of the taxpayer’s taxable income before the QBI deduction, minus any net capital gain.

Taxable Income Thresholds

The Internal Revenue Service sets annual income thresholds that determine how the QBI deduction is calculated. For the 2024 tax year, the threshold is $191,950 for single filers and most other filing statuses, and $383,900 for those married filing jointly. If a taxpayer’s taxable income before the QBI deduction is at or below these amounts, the calculation is straightforward. Once income exceeds these thresholds, additional rules and limitations may come into play.

Specified Service Trades or Businesses (SSTBs)

A Specified Service Trade or Business (SSTB) is a business involving the performance of services in specific fields. If a business is classified as an SSTB, the QBI deduction is subject to a phase-out once the owner’s taxable income exceeds the annual threshold. These fields include:

• Health
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services
• Any trade where the principal asset is the reputation or skill of one or more of its employees

For the 2024 tax year, this phase-out range is between $191,950 and $241,950 for single filers, and between $383,900 and $483,900 for those married filing jointly. Within this range, the amount of QBI eligible for the deduction is gradually reduced. If the taxpayer’s income exceeds the top of this phase-out range, the QBI deduction for that SSTB is completely eliminated.

The W-2 Wage and UBIA Limitation

For taxpayers with income above the thresholds who are not in an SSTB, the QBI deduction may be limited by another test. This limitation is the greater of two possible calculations. The first is 50% of the W-2 wages paid by the qualified business. The second is 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of all qualified property.

The UBIA of qualified property is the original purchase price of tangible, depreciable property used in the business that has not yet reached the end of its depreciable period. This includes assets like buildings, machinery, and equipment. The depreciable period for this purpose is the later of 10 years from the date the property was placed in service or the last day of the last full year of the asset’s regular depreciation schedule. The taxpayer’s QBI deduction for that specific business cannot exceed this calculated wage and property limit.

Claiming the Deduction on Your Tax Return

To claim the QBI deduction, you must report it correctly on your federal income tax return using specific IRS forms. The information from these forms is then carried over to your Form 1040. There are two primary forms for this purpose: Form 8995, Qualified Business Income Deduction Simplified Computation, and Form 8995-A, Qualified Business Income Deduction.

The choice between Form 8995 and Form 8995-A depends on your taxable income and business activities. Form 8995 is the simpler of the two and is used by taxpayers whose taxable income before the QBI deduction is at or below the annual thresholds. For 2024, this means taxable income at or below $191,950 for most filers or $383,900 for those married filing jointly. You must also not be a patron in a specified agricultural or horticultural cooperative to use this simplified form.

Form 8995-A is required for all other eligible taxpayers. This includes individuals whose taxable income exceeds the thresholds, those who operate an SSTB with income above the thresholds, and patrons of agricultural or horticultural cooperatives. This form is more detailed as it incorporates the complex calculations for the income limitations and the W-2 wage and UBIA of qualified property limitation.