Who Is Eligible for the QBI Deduction?

The Qualified Business Income (QBI) deduction, often referred to as the Section 199A deduction, offers a significant tax reduction opportunity for owners of certain businesses. Enacted as part of the Tax Cuts and Jobs Act of 2017, its purpose is to provide a tax break comparable to the corporate tax rate reduction, but for individuals who operate businesses structured as pass-through entities. This deduction allows eligible taxpayers to reduce their taxable income by up to 20% of their qualified business income. It is designed to stimulate economic growth by lessening the tax burden on small business owners and self-employed individuals.

Qualifying Business Income and Entities

Qualified Business Income (QBI) includes the net income, gain, deduction, and loss from a qualified trade or business, encompassing ordinary income and losses. QBI specifically excludes certain types of income, such as capital gains or losses, dividends, and interest income that is not properly allocable to a trade or business. It also excludes reasonable compensation paid to a taxpayer by an S corporation and guaranteed payments made to a partner in a partnership for services rendered.

The QBI deduction is available to owners of pass-through entities. These structures do not pay corporate income tax; instead, their income passes directly to owners’ personal tax returns, where it is taxed at individual rates. Common examples of eligible entities include sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs) taxed as partnerships or S corporations. Certain trusts and estates can also generate QBI. In contrast, C corporations are not eligible for this deduction because they are subject to corporate-level income tax.

Specified Service Trades or Businesses

A key factor influencing QBI deduction eligibility is whether a business is classified as a Specified Service Trade or Business (SSTB). An SSTB is any trade or business involving the performance of services in certain fields, including health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. The definition also extends to any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. This “reputation or skill” clause broadens the scope to capture other service-based activities not explicitly listed.

Being an SSTB does not automatically disqualify a taxpayer from the QBI deduction. The SSTB rules only apply above specific taxable income thresholds, which are adjusted annually for inflation. If a taxpayer’s overall taxable income falls below these thresholds, even if their business is an SSTB, they may still be eligible for the full QBI deduction. The deduction for SSTBs begins to phase out within a certain income range and is completely eliminated once taxable income exceeds the upper threshold.

Taxable Income Thresholds

A taxpayer’s overall taxable income significantly influences their eligibility for and the calculation of the QBI deduction. For the 2024 tax year, the lower taxable income threshold is $191,950 for single filers and $383,900 for married filing jointly. The upper taxable income threshold is $241,950 for single filers and $483,900 for married filing jointly.

There are three main scenarios based on a taxpayer’s taxable income. If a taxpayer’s taxable income is at or below the lower threshold, they are eligible for the full 20% QBI deduction, regardless of whether their business is an SSTB. For taxpayers with taxable income between the lower and upper thresholds, known as the phase-in range, the deduction begins to be limited. During this phase-in, the SSTB exclusion gradually takes effect. For non-SSTBs in this range, the W-2 wages and unadjusted basis of qualified property (UBIA) limitations begin to apply.

When a taxpayer’s taxable income exceeds the upper threshold, the rules become stricter. For SSTBs, no QBI deduction is permitted once their taxable income is above this upper limit. For non-SSTBs, the deduction is still available, but it becomes fully subject to the W-2 wage and UBIA limitations, which can significantly reduce the deductible amount. It is important to note that these thresholds apply to the taxpayer’s total taxable income, not just the income from their qualified business.

W-2 Wages and Unadjusted Basis of Qualified Property Limitations

For taxpayers whose taxable income exceeds the upper threshold, the QBI deduction for non-SSTBs becomes subject to additional limitations. These limitations are designed to direct the deduction towards businesses that demonstrate significant economic activity through payroll or capital investment. The deduction cannot exceed the lesser of 20% of the qualified business income or the greater of two specific calculations.

One limitation is based on W-2 wages paid by the qualified trade or business. The deduction cannot exceed 50% of the W-2 wages paid by the business. This rule encourages businesses to employ workers, as a larger payroll can potentially lead to a higher deduction. The other limitation involves both W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property. This calculation limits the deduction to 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of all qualified property. Qualified property refers to tangible depreciable property used in the trade or business.

These limitations phase in for taxpayers whose income falls within the phase-in range and fully apply once the taxpayer’s taxable income surpasses the upper threshold.