Which Factors Limit the QBI Deduction?

The Qualified Business Income (QBI) deduction, from Section 199A of the Internal Revenue Code, offers a tax benefit for owners of many small and self-employed businesses. It allows eligible taxpayers to deduct up to 20% of their qualified business income. This deduction applies to pass-through entities like sole proprietorships, partnerships, and S corporations. The provision is scheduled to expire for tax years after December 31, 2025, unless extended by Congress.

The final amount a taxpayer can claim is subject to a series of limitations. These constraints narrow the deduction based on the taxpayer’s income level, the nature of their business, and specific operational details like wages and property.

The Taxable Income Threshold

The first factor for the QBI deduction is the taxpayer’s taxable income, which directs the calculation toward a straightforward or complex path. For the 2025 tax year, the income thresholds are $197,300 for single and other filers, and $394,600 for those married filing jointly.

If a taxpayer’s taxable income before the QBI deduction falls at or below these amounts, the calculation is simplified. The deduction is the lesser of 20% of the qualified business income or 20% of the taxpayer’s taxable income, with adjustments for capital gains. The type of business is not a limiting factor for those under this income level, so subsequent limitations do not apply.

Conversely, when a taxpayer’s taxable income exceeds the established threshold, the calculation becomes more intricate. Crossing this income line triggers additional limitations that can reduce or eliminate the deduction. These subsequent tests are based on whether the business is a Specified Service Trade or Business (SSTB) and on the amount of W-2 wages paid and the value of business property.

Limitation for Specified Service Trades or Businesses

For taxpayers with income above the annual threshold, the nature of their business is the next consideration. The tax code identifies a category known as a Specified Service Trade or Business (SSTB), which is subject to stricter limitations. An SSTB is a business where the principal asset is the reputation or skill of its employees or owners, including fields such as:

• Health
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services
• Brokerage services

The SSTB limitation is designed to phase out the QBI deduction for higher-income individuals in these service-based professions. For the 2025 tax year, this phase-out occurs within a specific income range. For single filers, the range is between $197,300 and $247,300, and for joint filers, it is between $394,600 and $494,600. If a taxpayer’s income falls within this range, their QBI deduction is gradually reduced, and if it surpasses the top of this range, the deduction is eliminated.

To illustrate the phase-out, consider a single consultant with taxable income of $222,300. Their income is $25,000 above the $197,300 threshold. This excess is divided by the total phase-out range of $50,000 ($247,300 – $197,300), resulting in a 50% reduction percentage. Therefore, only 50% of their business income, W-2 wages, and property basis would be considered for the QBI calculation, reducing their potential deduction.

A de minimis exception allows a business with both SSTB and non-SSTB activities to avoid the SSTB classification. If a business has $25 million or less in gross receipts, it is not considered an SSTB if less than 10% of those receipts come from a specified service field. This exception provides a safe harbor for businesses that only dabble in a specified service area.

The W-2 Wage and UBIA of Qualified Property Limitation

For business owners whose income exceeds the taxable income threshold but who are not in an SSTB, a different limitation applies. This test, which also applies to SSTBs within their phase-out range, is based on the business’s investment in its workforce and assets. The QBI deduction is capped by the greater of two amounts: 50% of the W-2 wages paid, or 25% of the W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.

W-2 wages include the total compensation subject to wage withholding paid to employees during the tax year. It also includes certain employee salary-reduction contributions to retirement plans, such as those made to a 401(k). The calculation is specific to wages paid by the qualified trade or business that are properly allocable to the qualified business income.

UBIA of qualified property represents the original cost of tangible, depreciable property when it was first placed in service by the business. This includes assets like buildings, machinery, and equipment used to generate QBI. The basis is unadjusted, meaning it is not reduced by depreciation. The property must be held by the business at the end of the tax year and its depreciable period must not have ended.

Consider a non-SSTB owner with $200,000 in QBI, who paid $60,000 in W-2 wages and owns qualified property with a UBIA of $500,000. Their initial potential deduction is $40,000 (20% of QBI). Because their income is above the threshold, they must apply the limitation. The first calculation is 50% of W-2 wages, which is $30,000. The second is 25% of wages plus 2.5% of UBIA, which totals $27,500. The greater of these two amounts is $30,000, so the QBI deduction is limited to $30,000.

The Overall Taxable Income Limitation

After navigating the SSTB rules and the W-2 wage and UBIA limitation, one final test applies to all taxpayers. This is an overarching ceiling on the deduction amount. The final QBI deduction claimed cannot be more than 20% of the taxpayer’s taxable income, calculated before the QBI deduction and after subtracting any net capital gains.

This final limitation is distinct from the taxable income thresholds discussed earlier, which determine whether other limitations apply. In contrast, this overall limitation is a final cap on the deduction amount. It is applied after all other calculations and potential reductions have been made.

For example, a taxpayer has calculated a QBI deduction of $35,000 after applying all relevant SSTB or wage limitations. Their total taxable income before the QBI deduction is $150,000, and they have no net capital gains. The overall limitation is 20% of this taxable income, which amounts to $30,000. Because their calculated deduction of $35,000 exceeds this $30,000 cap, their final QBI deduction is reduced to $30,000.