What Qualifies as Qualified Business Income?

Defining Qualified Business Income

Qualified Business Income (QBI) represents the net amount of qualified items of income, gain, deduction, and loss derived from a qualified trade or business. This income must be effectively connected with a U.S. trade or business and included in taxable income. A qualified trade or business generally encompasses any regular, continuous activity undertaken for profit. It distinguishes active business operations from passive investment activities or employee services.

For instance, simply owning property and collecting rent without active management might not qualify as a trade or business. However, if the owner actively manages the property, handles repairs, and engages with tenants, it could meet the criteria. QBI is reduced by certain deductions, such as the deductible portion of self-employment tax, self-employed health insurance premiums, and contributions to qualified retirement plans like SEP or SIMPLE IRAs. This netting process ensures QBI reflects the true business profit before the Section 199A deduction.

Included Business Income

Income from various business structures can generate QBI if it stems from a qualified trade or business. Sole proprietorships, reporting income on Schedule C, typically produce QBI. Income flowing through partnerships and S corporations to their owners, often reported on Schedule K-1, generally constitutes QBI. This includes net profits, unreimbursed partnership expenses, and business interest expenses.

Rental real estate activities can also qualify as a trade or business, generating QBI, particularly if regular and continuous. The IRS issued Revenue Procedure 2019-38, establishing a safe harbor for rental real estate enterprises. Under this safe harbor, an enterprise can be treated as a trade or business for QBI purposes if specific criteria are met, such as maintaining separate books and records and performing at least 250 hours of rental services annually. These services can include advertising, negotiating leases, collecting rent, and performing maintenance.

To elect this safe harbor, taxpayers must maintain contemporaneous records, such as time reports or logs, detailing the hours, description, dates, and identity of individuals performing the services. The safe harbor applies to rental real estate held for rent production, including single or multiple properties. If an enterprise fails to meet the safe harbor requirements, it might still qualify as a trade or business under general tax principles if it meets the Section 162 definition.

Excluded Business Income

Not all income generated from business activities qualifies as QBI. Wages earned as an employee, reported on a W-2 form, are explicitly excluded from QBI. Guaranteed payments received by partners are also excluded from QBI. Income from C corporations does not qualify for the QBI deduction because they are separate taxable entities.

Certain investment income is also excluded from QBI. This includes capital gains or losses, dividend income, and interest income, unless directly allocable to the trade or business. Other excluded items are income earned outside the United States, foreign currency gains or losses, and certain annuities not connected to a trade or business.

Income from a Specified Service Trade or Business (SSTB) is a significant exclusion. An SSTB involves the performance of services in specific fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. It also includes any business where the principal asset is the reputation or skill of one or more of its employees or owners. Income from an SSTB is excluded only if a taxpayer’s taxable income exceeds certain thresholds, detailed in the next section.

Impact of Income Thresholds on QBI Qualification

A taxpayer’s overall taxable income level significantly impacts the QBI amount that qualifies for the deduction. The Section 199A deduction is subject to annual, inflation-adjusted taxable income thresholds. For the 2024 tax year, these thresholds begin at $191,950 for single filers and $383,900 for those married filing jointly. These amounts represent where QBI deduction limitations may apply.

For SSTB income, the QBI deduction phases out as taxable income exceeds the lower threshold. If taxable income falls within the phase-out range, QBI from an SSTB is gradually reduced. For 2024, the phase-out range for single filers is between $191,951 and $241,950, and for married filing jointly, it is between $383,901 and $483,900. If taxable income surpasses the upper threshold for an SSTB, QBI from that business is entirely eliminated.

For qualified trades or businesses that are not SSTBs, if taxable income exceeds the lower threshold, the QBI deduction is limited by W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property. The deduction is limited to the greater of 50% of W-2 wages or the sum of 25% of W-2 wages plus 2.5% of the UBIA of qualified property. Qualified property refers to tangible depreciable property used in the trade or business, such as buildings and equipment. This limitation ensures businesses with substantial capital investment or significant payroll benefit more from the deduction at higher income levels.