What Qualifies as Qualified Business Income (QBI)?

The Qualified Business Income (QBI) deduction, authorized by Section 199A of the Internal Revenue Code, offers a tax benefit for many self-employed individuals and small business owners. This deduction allows owners of pass-through entities, such as sole proprietorships, partnerships, and S corporations, to deduct up to 20% of their qualified business income. Established as part of the 2017 Tax Cuts and Jobs Act, it aimed to create more parity between the tax rates on C corporations and pass-through businesses. The QBI deduction is taken on an individual’s personal tax return, regardless of whether they itemize deductions or claim the standard deduction.

Core Definition of Qualified Business Income

Qualified Business Income (QBI) represents the net amount of income, gain, deduction, and loss derived from any qualified trade or business. This income must be effectively connected with a trade or business within the United States. QBI focuses on the net profit after ordinary and necessary business expenses, distinct from a business’s gross revenue.

A “qualified trade or business” encompasses most business activities, with specific exclusions. It generally refers to any trade or business that is not a specified service trade or business (SSTB) above certain income thresholds, or the trade or business of performing services as an employee. The activity must be conducted with continuity and regularity, and with a primary purpose of generating income or profit.

Income and Business Activities That Qualify

The QBI deduction applies to income from common pass-through business structures, including sole proprietorships, partnerships, S corporations, and LLCs taxed as any of these entities. This includes the deductible portion of self-employment tax, self-employed health insurance premiums, and contributions to qualified retirement plans like SEP or SIMPLE IRAs.

Businesses engaged in manufacturing, retail, or general consulting (when income is below specified service trade or business thresholds) typically generate qualified business income. Rental real estate activities can also qualify as a trade or business for QBI purposes. The IRS provides a safe harbor election for rental real estate enterprises to be treated as a trade or business, requiring specific record-keeping and service hour thresholds.

Income and Business Activities That Do Not Qualify

Certain types of income and business activities are excluded from Qualified Business Income. These include investment income (such as capital gains, dividends, and interest not directly related to a trade or business), wages received as an employee, reasonable compensation paid to an S corporation shareholder-employee, and guaranteed payments made to a partner. Income from a C corporation is also not eligible for the QBI deduction.

A significant exclusion applies to income from a “Specified Service Trade or Business” (SSTB) once a taxpayer’s income exceeds certain thresholds. An SSTB is generally defined as any trade or business involving the performance of services where the principal asset is the reputation or skill of its employees or owners. Examples include health, law, accounting, performing arts, consulting, athletics, and financial services. However, architecture and engineering services are specifically excluded from the SSTB definition.

Impact of Taxable Income on QBI Qualification

A taxpayer’s total taxable income influences the amount of Qualified Business Income that qualifies for the deduction. The deduction is subject to limitations based on taxable income, calculated before considering the QBI deduction itself. There are three general tiers of income thresholds that determine these limitations.

For the 2024 tax year, if a taxpayer’s taxable income is below $191,950 for single filers ($383,900 for married filing jointly), the QBI deduction is generally 20% of QBI. It is not subject to the W-2 wage and unadjusted basis immediately after acquisition (UBIA) of qualified property limitations. If the business is an SSTB and the taxpayer’s taxable income is below this lower threshold, the SSTB income fully qualifies for the deduction.

When taxable income falls within the phase-out range, which for 2024 is between $191,951 and $241,950 for single filers ($383,901 and $483,900 for married filing jointly), the QBI deduction becomes subject to W-2 wage and UBIA limitations. Within this range, the deduction is limited based on the lesser of 20% of QBI or a calculation involving the business’s W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property. For SSTBs within this range, the deduction is partially phased out, meaning only a portion of the QBI from the SSTB will qualify.

If a taxpayer’s taxable income exceeds the upper threshold of the phase-out range, which for 2024 is $241,950 for single filers ($483,900 for married filing jointly), the QBI deduction is fully subject to the W-2 wage and UBIA limitations. For SSTBs, if taxable income is above this upper threshold, no QBI deduction is permitted from that specified service trade or business. The ultimate deduction amount can be reduced or eliminated based on the taxpayer’s total income and the nature of their business.