The Qualified Business Income Deduction (QBI deduction) has become one of the most talked-about tax strategies for small and medium-sized businesses in recent years. If you are a sole proprietor, member of a partnership or LLC, or an S corporation shareholder, you may have heard that you can potentially deduct up to 20% of your qualified business income from your taxable income. This deduction, introduced under Section 199A of the Internal Revenue Code, was part of the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. Ever since, business owners have been looking for ways to maximize their tax savings, especially regarding this unique and potentially valuable deduction.
The purpose of this in-depth guide is to walk you through everything you need to know about the QBI deduction, including who qualifies, what business income is eligible, how the deduction works in 2023, 2024, and 2025, the phaseout thresholds that limit the deduction, and practical strategies for maintaining good documentation. Because this deduction can be somewhat complex, we’ll break it down into sections and sub-sections so you can easily refer back to the areas that pertain to your specific tax situation.
You will find references and links throughout this article to high-authority sources, such as the IRS, the U.S. Congress, and reputable tax policy research organizations. For instance, the IRS: Qualified Business Income Deduction page provides official guidance. This guide helps you see the bigger picture of how the deduction might apply to various business scenarios.
By the end of this guide, you should have a clearer understanding of what the qualified business income deduction is, how it can impact your overall tax liability, and the documentation required for a hassle-free filing experience. Let’s dive in.
Published: February 9, 2025
- What Is the Qualified Business Income Deduction (QBI Deduction)?
- Who is Eligible for the Deduction of Qualified Business Income?
- What Business Does Not Qualify for QBI Deduction?
- Is There a Limit on Qualified Business Income Deduction?
- Section 199A Dividends and Other Key Terms
- How Much Tax Savings Can You Expect?
- QBI Deduction Phase Out 2023, 2024, 2025
- Example Scenarios for Business Owners
- Best Practices for Documentation and Accuracy
- How to Claim the Qualified Business Income Deduction on Your Tax Return
- Frequently Asked Questions
- What is the Qualified Business Income Deduction?
- What Business Does Not Qualify for QBI Deduction?
- Is There a Limit on Qualified Business Income Deduction?
- What Are Section 199A Dividends?
- How Do I Calculate My Deduction Using a QBI Deduction Calculator?
- When Does the Deduction for Qualified Business Income Expire?
- Where Can I Learn More About the QBI Deduction Phase Out 2023, 2024, 2025?
- Conclusion
What Is the Qualified Business Income Deduction (QBI Deduction)?
The Qualified Business Income Deduction (QBI deduction) is often described as one of the most significant components of the 2017 Tax Cuts and Jobs Act for small business owners. Technically, it’s codified in Section 199A of the Internal Revenue Code (IRC). In broad terms, the deduction allows many owners of pass-through entities (sole proprietors, partnerships, S corporations, and some trusts) to potentially deduct up to 20% of the income they receive from those businesses.
A Brief History of Section 199A
- Enacted in 2017: Section 199A was introduced to help reduce the tax burden on small businesses, attempting to offer somewhat comparable tax relief to that corporations received via a rate reduction.
- Future Uncertainty: As of now, the current provisions for the QBI deduction are scheduled to expire or “sunset” after 2025 unless new legislation extends or modifies them.
Scope of the Deduction
- Income Eligible for the Deduction: Only “qualified business income” is eligible for this deduction.
- Potential 20% Deduction: If your business and personal taxable income meet specific criteria, you may deduct up to 20% of your net business income before calculating your final tax liability.
Why This Deduction Matters
- Significant Savings: A 20% deduction can substantially reduce taxable income, translating into thousands or tens of thousands of dollars in tax savings, depending on the size of your business.
- Boost for Pass-Through Entities: Historically, pass-through businesses (like partnerships and S corporations) have been subject to taxes at the individual level. This deduction helps lower their effective rate in a way that’s somewhat akin to the lower rates that many C corporations have enjoyed.
- Documentation Is Critical: Because of the deduction’s complexity, you need careful documentation of your business income, wages, and other factors.
For official information and continuous updates, the IRS Qualified Business Income Deduction FAQ is a good reference that explains various nuances.
Who is Eligible for the Deduction of Qualified Business Income?
Not every business automatically qualifies for the deduction for qualified business income. To determine eligibility, the IRS generally looks at two broad categories: the nature of the company itself and the owner’s taxable income.
Business Entities That May Qualify
- Sole Proprietorships: Individuals operating under their name or a DBA, reporting income on Schedule C of Form 1040.
- Single-Member LLCs: Treated as sole proprietorships for tax purposes unless the LLC elects otherwise.
- Partnerships and Multi-Member LLCs: Income passes through to partners or members, who report their share on their individual tax returns.
- S Corporations: Income passes through to shareholders, who then claim the QBI deduction on their personal returns.
- Certain Trusts and Estates: Some trusts and estates can qualify if they meet specific requirements.
Requirements Tied to the Business Activity
- Must Be a Qualified Trade or Business Under Section 199A: The business must be engaged in an activity recognized as a trade or business for tax purposes. This generally excludes hobby activities or passive investments that don’t rise to an active trade or business level.
- Ordinary Income Calculation: The business income you deduct can’t come from capital gains, dividends (other than certain Section 199A dividends from REITs or publicly traded partnerships), or other excluded categories.
Personal Taxable Income Thresholds
- Single Filers and Married Filing Jointly: The QBI deduction can phase out if your taxable income exceeds a certain threshold. These thresholds are adjusted annually to account for inflation.
- Threshold Example for 2023: While exact figures may change, the approximate thresholds are around $182,100 for single filers and $364,200 for married filing jointly (figures adjusted annually).
- If Your Income Exceeds the Threshold: You may still qualify, but additional tests and limitations apply, mainly if you run a Specified Service Trade or Business (SSTB).
Keeping track of these changing thresholds is crucial. You can find updated numbers for each tax year on the website under their QBI deduction section.
What Business Does Not Qualify for QBI Deduction?
While many businesses do qualify for the QBI deduction, not all do. The tax code excludes specific categories of income and businesses from fully benefiting, particularly if the owner’s taxable income surpasses the threshold amount.
Specified Service Trades or Businesses (SSTBs)
If your business is classified as an SSTB and your personal taxable income is above the phaseout range, you may not receive the QBI deduction at all, or it may be significantly limited. SSTBs generally include businesses in:
- Health
- Law
- Accounting
- Consulting
- Financial services
- Actuarial science
- Athletics
- Performing arts
- Brokerage services
- Trading, dealing in specific securities
- Any business where the principal asset is the reputation or skill of one or more employees or owners
According to the IRS final regulations on Section 199A and clarifications in subsequent guidance, these services are singled out because Congress wanted to limit the extent to which professional, high-income individuals could take advantage of the 20% pass-through deduction.
Types of Income That Do Not Qualify
Even if your overall business is eligible, certain types of income cannot be included when calculating your QBI deduction:
- Capital Gains and Losses
- Dividends (unless they’re Section 199A dividends from qualified REITs or PTPs)
- Interest Income Not Allocable to the Business
- Wage Income Paid to the Owner as an Employee
- Foreign Income (not effectively connected to a U.S. trade or business)
Importance of Classification
If your activities straddle the line—perhaps you offer both consulting services (an SSTB) and a tangible product line (a qualified activity)—a thoughtful approach to structuring your operations may help optimize the deduction. Proper recordkeeping and entity structuring can help separate qualifying income from non-qualifying income.
Is There a Limit on Qualified Business Income Deduction?
One of the most common questions business owners ask is: “Is there a limit on qualified business income deduction?” The short answer is yes. The QBI deduction can be limited by various factors, including your overall taxable income, the type of business, how much you pay in W-2 wages, and the depreciable assets your business holds.
Taxable Income Thresholds
- Lower Threshold: If you file a single return and have taxable income below $182,100 (for 2023, subject to annual adjustments), or if you file a joint return and have taxable income below $364,200 (again for 2023), you generally receive the full 20% deduction on QBI, provided your business is not disqualified.
- Above the Threshold: Once you exceed these amounts, you must account for more complex calculations:
- W-2 Wage Limitation: The deduction may be limited to the lesser of 20% of QBI or 50% of your share of W-2 wages paid by the business.
- Alternative Limitation: Alternatively, it could be limited to 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property.
Phaseouts for Specified Service Trades or Businesses
For SSTBs (e.g., law, accounting, consulting) that exceed the threshold, the deduction starts to phase out over a defined income range. Beyond a certain taxable income level, the deduction is fully phased out. Updated phaseout numbers are published each year by the IRS.
Impact of the Deduction for Qualified Business Income 2023, 2024, 2025
- Annual Adjustments: Each year, the IRS adjusts the threshold figures for inflation, so the numbers for 2024 and 2025 will likely be higher than those for 2023.
- Expiration in 2025?: Under current law, the QBI deduction is scheduled to expire after 2025. This deduction may not exist in 2026 and beyond unless new legislation is passed.
Section 199A Dividends and Other Key Terms
When exploring the QBI deduction, you’ll frequently come across references to “Section 199A” because that’s the part of the Internal Revenue Code that authorizes this deduction. Let’s clarify some of the key terms:
Section 199A
- What It Is: Section 199A was created by the Tax Cuts and Jobs Act of 2017 to provide a deduction for pass-through income.
- Primary Purpose: It aims to treat pass-through entities more favorably for federal income tax purposes, somewhat like how C corporations received a permanent tax rate reduction.
What Are Section 199A Dividends?
- Definition: Section 199A dividends typically refer to dividends from Real Estate Investment Trusts (REITs) or qualified Publicly Traded Partnerships (PTPs) that fall under the rules of Section 199A.
- Eligibility: These dividends may qualify for a 20% deduction in certain circumstances, even though they are not “business income” per se.
- Importance: If you invest in a REIT or PTP, you might see a box on your Form 1099-DIV labeled “Section 199A dividends.” These amounts can be included in your QBI deduction calculations, offering an additional benefit.
Qualified Trade or Business Under Section 199A
- Broad Definition: A qualified trade or business generally means any trade or business, except for SSTBs above the income threshold or the business of performing services as an employee.
- Examples: Retail, manufacturing, certain real estate activities, technology services (non-SSTB categories), and more.
How Much Tax Savings Can You Expect?
The potential tax savings from the QBI deduction can be significant, but it’s crucial to remember that every situation is unique. Factors such as your filing status, total taxable income, your type of business, and whether you pay W-2 wages all play a role.
General Overview of Potential Savings
- 20% Deduction: You can deduct 20% of your net qualified business income in an ideal scenario with no phaseouts or limitations.
- Example:
- Suppose a sole proprietor has $100,000 in net profit.
- Assuming no limitations or phaseouts, the QBI deduction might be $20,000 (i.e., 20% of $100,000).
- If this individual’s marginal tax rate is 24%, the $20,000 deduction could theoretically yield a $4,800 tax savings.
QBI Deduction Calculator
To estimate your QBI deduction, you can use a QBI deduction calculator from reputable tax software providers or from certain CPA firm websites. These calculators typically ask for:
- Filing status
- Total taxable income
- Business income from each pass-through entity
- W-2 wages paid by the business
- The unadjusted basis of qualified property
Entering all relevant details can give you a rough approximation of how much you might save. Nonetheless, consult reliable tax guidance for a precise figure and ensure your records are accurate.
Practical Notes on Maximizing Savings
- Timing of Income and Deductions: If you’re close to a taxable income threshold, you might strategically defer or accelerate certain income or expenses to remain below the cutoff.
- Entity Structure: Some business owners reevaluate whether to be taxed as an S corporation or remain a sole proprietor, especially if W-2 wages factor heavily into the computation.
QBI Deduction Phase Out 2023, 2024, 2025
One of the biggest concerns for business owners is how the QBI deduction thresholds and limits might change from year to year. Understanding the “phaseout” is critical if your income exceeds the threshold.
Key Changes for Each Tax Year
- 2023: The phaseout thresholds for single filers and married couples filing jointly are set around $182,100 and $364,200, respectively (subject to inflationary adjustments).
- 2024: These figures typically increase to account for inflation, so check the IRS’s annual updates for the new year’s amounts.
- 2025: The deduction remains in effect through 2025, but thresholds will likely be incrementally adjusted again. After December 31, 2025, the deduction is set to expire under the original legislative design unless extended by Congress.
Why This Matters
- Staying Below the Threshold: Understanding these thresholds is crucial if you operate a specified service trade or business. Even a slight difference in income can mean losing the deduction entirely.
- Mid-Year Tax Planning: Because the IRS usually updates threshold numbers well before the end of the prior year, plan with your CPA or financial advisor to manage your income streams accordingly.
Planning Strategies
- Deferral or Acceleration of Income: If you’re close to the threshold, you may try to push certain income into the following tax year (if your situation allows) or accelerate it into the current year, depending on your goals.
- Reevaluate Business Structure: Switching from a sole proprietorship to an S corporation might help manage W-2 wages effectively for owners, but it comes with administrative burdens.
- Retirement Contributions: Contributions to certain retirement accounts can reduce your taxable income, potentially helping you stay under the limit and maximize the deduction.
For a deeper look at how inflation adjustments might affect the QBI deduction beyond 2023, check out TaxFoundation.org’s analysis of federal tax bracket updates.
Example Scenarios for Business Owners
Understanding theory is one thing, but seeing how it works in real life can be more illuminating. Below are two simplified scenarios illustrating how the QBI deduction might apply in different business setups.
Scenario A: Single-Member LLC with $75,000 Net Profit
Meet Sarah, who operates a single-member LLC marketing advertising company. Her total net profit for the year is $75,000, and her taxable income after personal deductions is around $65,000.
- Check for Eligibility:
- She’s well below the 2023 threshold for single filers (approx. $182,100).
- She’s not in an SSTB category that’s automatically excluded.
- Calculate the Deduction:
- QBI might be $75,000.
- 20% of $75,000 is $15,000.
- Sarah could reduce her taxable income by $15,000.
- Potential Tax Savings:
- If Sarah’s marginal tax rate is, say, 22%, the deduction might save her approximately $3,300 in federal income taxes (22% of $15,000).
- Documentation Needed:
- She should maintain well-organized records of her business income and expenses (e.g., accounting software logs, receipts, and bank statements).
Scenario B: S Corporation with $300,000 Net Income and Two Owners
Meet Bob and Lisa, who run an S corporation that develops custom software. The company’s net business income is $300,000 after all expenses. Bob and Lisa each own 50%. The business pays out $100,000 in W-2 wages to each owner for their roles in the company (so total W-2 wages = $200,000), leaving $100,000 of net pass-through profit.
- Check for Eligibility:
- Bob and Lisa each receive $50,000 of pass-through income in addition to their W-2 wages.
- Their personal taxable income could be above or below the threshold, depending on other factors like spousal income and itemized deductions.
- Phaseout Consideration:
- If each has taxable income below the phaseout threshold, each could claim 20% of $50,000 = $10,000 as a QBI deduction (subject to the wage limitation, which is likely satisfied due to high W-2 wages).
- Potential Tax Savings:
- If they each save around $2,200 (22% marginal rate x $10,000) in federal taxes combined, they could save $4,400.
- Importance of Properly Setting W-2 Wages:
- If Bob and Lisa had underpaid themselves with W-2 wages, they might have run afoul of reasonable compensation rules for S corporation owners.
- If they overpay in W-2 wages, the pass-through portion of profit decreases, which might reduce the QBI deduction. A balanced approach is key.
Best Practices for Documentation and Accuracy
One of the crucial points in any discussion about the QBI deduction is the importance of recordkeeping and documentation. Because the deduction can be large, the IRS may scrutinize returns claiming it.
Recordkeeping Essentials
- Accurate Financial Statements: Keep updated profit and loss statements, balance sheets, and other reports generated by accounting software.
- Invoices and Receipts: Maintain digital or paper copies of sales, purchases, and overhead costs.
- Payroll Records: If you pay employees or are an S corporation owner-employee, robust payroll documentation is essential for verifying W-2 wages.
- Ownership Agreements: If you have partners, LLC members, or S corporation shareholders, keep documentation that clarifies ownership percentages and responsibilities.
Tax Return Support
- Schedule C (for Sole Proprietors): Ensure every figure flows consistently from your accounting records.
- Form 1065 (Partnerships) or 1120-S (S Corporations): Double-check that your business tax return aligns with your personal return.
- Form 8995 or 8995-A: These specialized forms calculate the QBI deduction. Correctly filling them out is key to minimizing errors.
Why Good Documentation Matters
- Audit Protection: Poor documentation could lead to adjustments, interest, and penalties if the IRS audits your return and disallows all or part of the QBI deduction.
- Accurate Planning: Real-time, accurate data allows you to make mid-year tax planning decisions to manage your income in ways that optimize the QBI deduction.
For more detailed guidance, the IRS Publication 535: Business Expenses covers various allowable deductions, which can tie into your QBI calculation.
How to Claim the Qualified Business Income Deduction on Your Tax Return
Identify the Correct Form
- Form 8995: For more straightforward QBI situations, where your taxable income is under the threshold and no complicated calculations are required.
- Form 8995-A: For more complex situations, especially when dealing with phaseouts, W-2 wage limitations, and multiple pass-through entities.
Collect All Relevant Documents
- Business income statements ensure you’ve separated qualified business income from capital gains or other excluded sources.
- W-2 forms if you have employees or are an S corporation owner-employee.
- Information about your unadjusted basis in qualified property (if relevant).
Watch Your Taxable Income Carefully
- Your calculation may be straightforward if your taxable income is below the phaseout threshold.
- If your income is above the threshold, be prepared for a more detailed approach involving W-2 wages, the unadjusted basis of assets, and the type of business (SSTB or not).
When It Expires
- As written, the deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026.
- There has been talk about extending or making the deduction permanent, but no final legislation has been passed at the time of writing. You can track the legislative status by visiting Congress.gov’s TCJA updates to see if any new bills have been introduced.
Frequently Asked Questions
What is the Qualified Business Income Deduction?
The qualified business income deduction, or the QBI deduction, is a potential 20% deduction on the net profits you earn from certain pass-through businesses, per Section 199A of the Internal Revenue Code. It was introduced to help business owners lower their taxable income and, therefore, their overall tax liability.
What Business Does Not Qualify for QBI Deduction?
While many businesses can claim the deduction, not all qualify. Generally excluded are specified service trades or businesses (e.g., certain professional services like law, accounting, health, consulting) if the owner’s taxable income exceeds IRS thresholds. Income from capital gains, interest, and certain dividends is also excluded.
Is There a Limit on Qualified Business Income Deduction?
Yes. For taxpayers above certain income thresholds, the deduction can be limited by W-2 wages paid, the unadjusted basis in qualified property, and whether the business is an SSTB. If your taxable income is below the threshold, you can usually claim the full 20% deduction on eligible business income.
What Are Section 199A Dividends?
Section 199A typically refers to dividends from Real Estate Investment Trusts (REITs) or qualified publicly traded partnerships. These dividends appear in box 5 of Form 1099-DIV. They may qualify for a separate 20% deduction under Section 199A rules if you receive them, even though they’re not strictly “business income.”
How Do I Calculate My Deduction Using a QBI Deduction Calculator?
A QBI deduction calculator will generally ask for your net business income, filing status, total taxable income, W-2 wages paid, and the unadjusted basis of certain business assets. You can estimate how much you might deduct by entering all your data accurately. Stay updated on annual threshold changes, or check official sources like the IRS website for the most recent numbers.
When Does the Deduction for Qualified Business Income Expire?
Under the Tax Cuts and Jobs Act, the deduction is set to expire at the end of 2025. Unless Congress acts to renew or modify it, your 2025 tax return will be the last one eligible for this particular deduction.
Where Can I Learn More About the QBI Deduction Phase Out 2023, 2024, 2025?
You can visit the IRS’s guidance on Section 199A or check legislative updates on Congress.gov for information about how the thresholds change yearly. For more analytical takes, consider reputable resources like TaxFoundation.org.
Conclusion
The qualified business income deduction has undeniably reshaped the tax landscape for pass-through businesses in the United States. By allowing eligible owners to deduct up to 20% of their net income potentially, the deduction can result in substantial tax savings—provided you navigate the rules correctly. This means understanding whether your business structure qualifies, staying informed about yearly threshold changes, recognizing when phaseouts may apply, and meticulously documenting your income, wages, and business assets.
Done correctly, the QBI deduction can serve as a cornerstone of your annual tax planning strategy, especially as you look ahead to 2023, 2024, and 2025. Since the deduction’s future beyond 2025 is uncertain, it’s wise to capitalize on it while it’s available. Keeping updated through resources like the IRS official website on the QBI deduction can help you stay one step ahead.
If you want to ensure you’re handling your deduction for qualified business income most optimally—or if you need personalized guidance on how to qualify, handle phaseouts, and keep solid documentation—let our CPA firm help. We specialize in making these complex rules simple and beneficial for your business’s unique needs. Explore our hands-on approach to QBI deductions and more by becoming a tax client, and discover how the right tax strategy can enhance your overall financial well-being.