Qualified Business Income (QBI) Deduction FAQ

The Qualified Business Income (QBI) deduction, established under IRC Section 199A by the Tax Cuts and Jobs Act of 2017, allows eligible taxpayers to deduct up to 20% of qualified business income from pass-through entities. This includes income from sole proprietorships, partnerships, S corporations, and certain trusts and estates. The deduction reduces taxable income, effectively lowering the tax rate on qualifying business income.

For example, if you have $100,000 of qualified business income from your sole proprietorship, you can potentially deduct $20,000 (20% x $100,000), meaning you only pay income tax on $80,000. For a taxpayer in the 24% tax bracket, this translates to $4,800 in tax savings. The deduction was created to provide tax parity between pass-through business owners and C corporations, which received a reduced 21% corporate tax rate under the same legislation.

The QBI deduction is an "above-the-line" deduction but is calculated after adjusted gross income (AGI). It reduces taxable income but does not affect self-employment tax calculations. The deduction is available for tax years 2018 through 2025 unless Congress acts to extend or make it permanent. Taxpayers claim the deduction on Form 8995 (simplified version) or Form 8995-A (for complex situations).

The QBI deduction is available to individuals, trusts, and estates that receive qualified business income from pass-through entities. Qualifying business structures include:

• Sole Proprietorships: Business income reported on Schedule C of Form 1040
• Partnerships: Income from partnerships reported on Schedule K-1 (Form 1065)
• Limited Liability Companies (LLCs): Single-member LLCs (treated as sole proprietorships) or multi-member LLCs (treated as partnerships)
• S Corporations: Income from S corporations reported on Schedule K-1 (Form 1120-S)
• Trusts and Estates: Qualified business income distributed to or retained by trusts and estates
• Rental Real Estate: If the activity rises to the level of a trade or business or meets the safe harbor requirements

Who Does NOT Qualify:

• C corporations (income taxed at corporate level at flat 21% rate)
• Employees (W-2 wages are not QBI)
• Businesses conducted outside the United States

Income Limitations: For 2024, the deduction calculation becomes more complex when taxable income exceeds $191,950 (single) or $383,900 (married filing jointly). Above these thresholds, wage and property limitations and SSTB rules begin to apply. Complete phase-out occurs at $241,950 (single) or $483,900 (MFJ).

A Specified Service Trade or Business (SSTB) is a trade or business involving the performance of services in certain professional fields. Under IRC Section 199A(d)(2), SSTBs include businesses in the fields of:

• Health: Medical services, dentistry, nursing, veterinary services, physical therapy, psychology, and similar healthcare services
• Law: Legal services including attorneys, paralegals, and legal support
• Accounting: Services requiring accountant licensure including tax preparation, auditing, and bookkeeping
• Actuarial Science: Actuarial services and analysis
• Performing Arts: Services by actors, singers, musicians, entertainers, and similar performers
• Consulting: Provision of professional advice and counsel (with exceptions for embedded services in product sales)
• Athletics: Services by athletes, coaches, and team managers
• Financial Services: Wealth management, financial planning, investment management, and similar services
• Brokerage Services: Services by brokers arranging transactions between parties for commission
• Reputation/Skill: Any trade or business where the principal asset is the reputation or skill of one or more employees or owners

Important: Engineering and architecture are specifically EXCLUDED from SSTB classification and can claim the full QBI deduction regardless of income level.

SSTB Limitations: If your taxable income exceeds the threshold amounts ($191,950 single/$383,900 MFJ for 2024), the QBI deduction for SSTB income phases out. Above the full phase-out amounts ($241,950/$483,900), taxpayers with SSTB income receive NO QBI deduction for that business income.

The QBI deduction calculation depends on your taxable income level:

Below Threshold (Under $191,950 single / $383,900 MFJ for 2024):

The deduction equals the LESSER of:

• 20% of Qualified Business Income, OR
• 20% of taxable income minus net capital gains (including qualified dividends)

This is the simplified calculation - no wage or property limitations apply, and SSTB status does not matter.

Above Threshold but Below Full Phase-Out ($191,950-$241,950 single / $383,900-$483,900 MFJ):

The W-2 wage and qualified property limitations begin to phase in. The deduction is limited to the GREATER of:

• 50% of W-2 wages paid by the qualified trade or business, OR
• 25% of W-2 wages PLUS 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property

The limitation phases in ratably over the $50,000 range ($100,000 for MFJ). SSTB income also phases out in this range.

Above Full Phase-Out ($241,950+ single / $483,900+ MFJ):

The wage/property limitations fully apply. SSTB income receives NO QBI deduction. Non-SSTB businesses are limited to the wage/property formula above.

Qualified Business Income (QBI) is the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. The following items ARE included in QBI:

• Ordinary business income and loss
• Section 1231 gains and losses (treated as ordinary income for QBI purposes)
• Self-employment income (net of the deductible portion of self-employment tax)
• Income from rental real estate if it qualifies as a trade or business
• Effectively connected income of a domestic trade or business

The following items are specifically EXCLUDED from QBI under IRC Section 199A(c)(3):

• Capital gains and losses (including Section 1231 gains taxed as capital gains)
• Dividends and dividend equivalents
• Interest income not properly allocable to a trade or business
• Wage income received as an employee (W-2 wages)
• Guaranteed payments to partners for services rendered
• Reasonable compensation paid to S corporation shareholders
• Payments to partners for services under Section 707(a)
• Any qualified REIT dividends or qualified publicly traded partnership income (these have their own 20% deduction)
• Income from businesses conducted outside the United States
• Commodities gains or losses
• Foreign currency gains or losses

Each qualified trade or business is calculated separately. Losses from one qualified business reduce QBI from other businesses in the current year or are carried forward to reduce QBI in future years.

Rental real estate income may qualify for the QBI deduction if the rental activity rises to the level of a trade or business under Section 162. The IRS provided a safe harbor in Revenue Procedure 2019-38 that allows taxpayers to treat rental real estate enterprises as trades or businesses for QBI purposes if specific requirements are met.

Safe Harbor Requirements (Rev. Proc. 2019-38):

• Separate books and records are maintained for each rental real estate enterprise
• 250 or more hours of rental services are performed per year for the enterprise (can include owner time, employee time, and contractor time for certain activities)
• Contemporaneous records are maintained documenting: hours of services performed, description of services, dates performed, and who performed the services
• The taxpayer attaches a statement to the return signed under penalties of perjury

Qualifying Rental Services Include: Advertising, negotiating and executing leases, tenant screening, rent collection, daily operation and maintenance, managing repairs, purchasing materials, supervising employees and contractors.

Activities That Do NOT Qualify:

• Triple net lease arrangements (tenant pays taxes, insurance, and maintenance)
• Property rented to a commonly controlled trade or business (generally same owners)
• Financial or investment management activities, studying financial statements, travel time

If the safe harbor is not met, rental income may still qualify for the QBI deduction if facts and circumstances demonstrate the activity rises to the level of a trade or business under the general Section 162 standards - regular, continuous, and considerable activity with profit intent.

For taxpayers with taxable income above the threshold amount ($191,950 single / $383,900 MFJ for 2024), the QBI deduction is limited based on W-2 wages paid and/or qualified property used by the business. The deduction for each qualified trade or business is limited to the GREATER of:

Option A (Wage-Only Test): 50% of W-2 wages paid by the qualified trade or business

Option B (Wage + Property Test): 25% of W-2 wages PLUS 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property

W-2 Wages Include:

• Total wages paid to employees that are reported on Form W-2
• Elective deferrals to retirement plans
• Deferred compensation
• Only wages properly allocable to QBI

W-2 Wages Do NOT Include: Payments to independent contractors, guaranteed payments to partners, or compensation paid to S corporation shareholders that is not reported on W-2.

Qualified Property: Tangible, depreciable property held at the close of the tax year, used in the production of QBI, and within its depreciable period. The depreciable period is the later of: 10 years from the date placed in service, or the last day of the full depreciation period under Section 168.

Example: A sole proprietor with no employees has $200,000 QBI and owns $500,000 of qualified equipment. Option A yields $0 (no wages). Option B yields $12,500 (25% x $0 + 2.5% x $500,000). The QBI deduction is limited to $12,500, not $40,000 (20% of QBI).

Yes, you can claim the QBI deduction if you have multiple businesses and some generate income while others generate losses, but the losses affect your deduction. Here's how losses are treated:

Current Year Treatment: If you have multiple qualified trades or businesses, losses from one business reduce QBI from other businesses. Your combined QBI is calculated by netting all qualified income and losses. If the combined total is positive, you calculate the 20% deduction on that net amount. If combined QBI is zero or negative, no current-year deduction is available.

QBI Loss Carryforward: When combined QBI is negative, the loss is carried forward to subsequent years as a "QBI loss carryforward." In future years, this carryforward is treated as a loss from a separate trade or business and reduces your QBI deduction. The carryforward is allocated proportionally among businesses with positive QBI in the subsequent year.

Key Differences from NOL:

• QBI loss carryforward does NOT expire (unlike old NOL rules)
• QBI loss is NOT limited to 80% of taxable income
• QBI loss ONLY reduces QBI deduction, not other income
• QBI loss is calculated separately from net operating loss

Prior Year Losses: Business losses incurred in years before 2018 do not create QBI loss carryforwards, but net operating losses from prior years that carry forward and reduce current-year taxable income can indirectly increase your QBI deduction by lowering your taxable income below the threshold amounts.