Get Advice

The QBI Deduction for Small Businesses: What You Need to Know

Navigating the tax code can be daunting for small business owners, but the Qualified Business Income (QBI) deduction is one of the most valuable tax breaks available. Enacted as part of the 2017 Tax Cuts and Jobs Act, it can reduce your effective tax rate by up to 20% on your business income.

This guide breaks down the QBI deduction in simple terms, explaining what it is, who qualifies, and how to claim it.

What Exactly is the QBI Deduction?

The QBI deduction, also known as the Section 199A deduction, allows eligible pass-through business owners to deduct up to 20% of their qualified business income on their federal income taxes.

  • Pass-Through Businesses: This is the key. It applies to businesses whose income “passes through” to the owner’s personal tax return, rather than being taxed at the corporate level. This includes:

    • Sole Proprietorships (Schedule C)

    • Partnerships (Schedule K-1)

    • S Corporations (Schedule K-1)

    • Limited Liability Companies (LLCs) taxed as any of the above

Important: It is an above-the-line deduction, meaning you can take it even if you don’t itemize your deductions. It directly reduces your taxable income.

Who Qualifies? The Basic Rules

While the concept is simple, the rules have important complexities based on your income and the type of business you run.

1. The Income Thresholds (2024 Tax Year)

Your eligibility and the deduction’s complexity largely depend on your taxable income.

  • Below $191,950 (Single) / $383,900 (Married Filing Jointly): The rules are simpler. You can generally claim the full 20% deduction of your QBI, subject to a few limitations.

  • Above $191,950 (Single) / $383,900 (Married Filing Jointly): The rules become more complex. The deduction may be limited or phased out based on your business type, the W-2 wages it pays, and the value of its property.

What is “Qualified Business Income” (QBI)?

QBI is the net amount of qualified items of income, gain, deduction, and loss from your pass-through business. In simple terms, it’s generally your net business profit.

It Includes:

  • Business profits reported on Schedule C, K-1, etc.

  • Real estate investment trust (REIT) dividends

  • Qualified publicly traded partnership (PTP) income

It Excludes:

  • Capital gains or losses

  • Dividends and interest income

  • Wage income (as an employee)

  • Guaranteed payments to partners (in a partnership)

The Major Complication: Specified Service Trades or Businesses (SSTBs)

The tax code places restrictions on owners of “Specified Service Trades or Businesses” (SSTBs) once their income exceeds the threshold mentioned above.

What is an SSTB? A business where the principal asset is the reputation or skill of one or more of its owners or employees. This includes:

  • Health, law, accounting, and consulting

  • Financial services

  • Performing arts

  • Athletics

  • Any business where its reputation is tied to a specific individual (e.g., a celebrity endorser)

The SSTB Rule:

  • Below the income threshold: SSTB owners can take the full QBI deduction.

  • Within the phase-in range ($191,950-$241,950 Single / $383,900-$483,900 Married): The deduction for SSTBs is gradually phased out.

  • Above the phase-out range: SSTB owners receive no QBI deduction.

How is the Deduction Calculated? (A Simplified Overview)

The calculation can be complex, but it essentially follows this logic:

  1. Determine your QBI (your net business profit).

  2. Calculate 20% of your QBI.

  3. Compare it to the Limitation (if your income is above the threshold). The limitation is the greater of:

    • 50% of the W-2 wages paid by the business, or

    • 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of all “qualified property” (like equipment and buildings).

  4. Your deduction is the lesser of:

    • 20% of your QBI, or

    • The W-2/property limitation (if it applies).

A Practical Example

Let’s imagine a married couple, Jane and John, who own a small manufacturing company (a non-SSTB) as an S Corp.

  • Taxable Income: $500,000 (above the $383,900 threshold)

  • Business QBI: $400,000

  • W-2 Wages Paid by Business: $150,000

  • Qualified Property: $200,000

  1. 20% of QBI: $400,000 x 20% = $80,000

  2. W-2/Wage Limitation Calculation:

    • 50% of W-2 Wages: $150,000 x 50% = $75,000

    • (25% of W-2 Wages) + (2.5% of Property): ($150,000 x 25% = $37,500) + ($200,000 x 2.5% = $5,000) = $42,500

    • The greater of these two is $75,000.

  3. Deduction Amount: The lesser of $80,000 (20% of QBI) and $75,000 (the limitation) = $75,000.

Result: Jane and John can deduct $75,000 from their taxable income, saving them thousands of dollars in taxes.

Key Takeaways for Small Business Owners

  1. It’s a Major Benefit: For many, this is a massive tax saving that shouldn’t be overlooked.

  2. Know Your Business Type: Determine if you are an SSTB, as this critically impacts your eligibility at higher income levels.

  3. Pay W-2 Wages: For businesses that can support it, paying W-2 wages (even to owners) can be crucial for maximizing the deduction above the income thresholds.

  4. Document Everything: Keep meticulous records of your business income, wages paid, and capital asset purchases.

  5. Consult a Professional: The QBI deduction is complex, especially near the income thresholds. Working with a qualified tax professional or CPA is highly recommended to ensure you are calculating it correctly and maximizing your savings.

The QBI deduction is a powerful tool. Understanding its fundamentals empowers you to have more informed conversations with your accountant and make strategic decisions for your business’s financial health.